China’s coming stimulus is necessary but likely insufficient

The standing committee of China’s legislature opened a session on Monday, and investors will be looking for indications of the size of any coming fiscal stimulus. Estimates vary but center on around 10 trillion yuan, the equivalent of $1.4 trillion.

While the headline figure is important, investors should also look at how the money is actually spent. Judging from what the government has said so far, it may not be all that stimulative.

A big part of the program will likely be to restructure the debt of local governments. These local governments have racked up piles of debt over the years as they are responsible for the bulk of public spending from infrastructure to education, but lack reliable revenue sources to match. That includes borrowing through some off-balance-sheet vehicles called local government financing vehicles, or LGFVs. Local governments used these obscure state-owned entities to sidestep borrowing limits imposed by Beijing. Goldman Sachs estimates that LGFV debt was around 60 trillion yuan at the end of 2022.

China’s housing market implosion has drastically reduced proceeds from land sales, a major source of income for local governments. They in turn have cut spending and raised fees levied on local residents, which has further depressed the economy. Goldman Sachs estimates there is a 2.3 trillion yuan government revenue shortfall this year.

Beijing could take on some of the debt burden of local governments. That would help reduce their interest expenses and free up their financial capacity to spend.

Another big part of the stimulus will likely go to tackle the root cause of the current economic malaise—the housing crisis. The central government could issue bonds to buy some of the millions of unsold homes. J.P. Morgan estimates that 4 trillion to 5 trillion yuan is needed to bring inventory down to a level where home prices may start to stabilize. That isn’t a new policy per se: Local governments were directed to start clearing out excess inventory earlier this year, but they don’t really have the fiscal wherewithal to carry out the policy. More direct funding from the central government may help.

There will also likely be some stimulus aimed at consumption, like upgrading welfare payments and trade-in subsidies for consumer goods. But this part may miss investors’ expectations given Beijing’s long hesitancy to give direct handouts. The austerity that has been imposed on property developers and local governments has already sunk the economy into a deflationary spiral. While addressing local government debts and housing inventory are important, these may only be measures that prevent the worst, while not being enough to propel growth.

One reason Beijing may not be willing to embark on a large consumption stimulus is that debt has been rising while tax revenues are declining. Official figures of China’s debt put it at just over 50% of GDP, including the central and local governments. But including off-balance-sheet LGFV’s, China’s public debt to GDP ratio has risen from 73% in 2019 to 102% as of June quarter, according to Morgan Stanley.

China’s stimulus package will probably put the economy on a more stable footing. But don’t expect growth to kick up a gear.

Write to Jacky Wong at jacky.wong@wsj.com