More debts or not, Beijing faces a thorny question

Two months later, policymakers have shown little sign of changing their minds despite a worrying run of economic data that has only worsened since Li’s speech as a protracted property slump drags on.

That has sparked concern that Chinese leaders are repeating mistakes made by Japan in the 1990s, when the lack of sufficient easing measures eventually led to a prolonged recession following a collapse in asset prices. Already, global banks have cut their expectations for China’s economic growth, with many believing the official target of around 5% for 2024 is at risk without stronger policy support to come.

With monetary easing constrained by authorities’ worries around an extended bond rally and banks’ squeezed profit margins, economists are increasingly zeroing in on lagged fiscal support, raising questions about authorities’ reluctance to take on extra debt.

In particular, China’s subnational governments, which shoulder most of the country’s total fiscal expenditures, have been pushed by Beijing to pay down debts, a mandate that has propelled many to cut public spending and take a more cautious approach to borrowing.

“Despite the mounting funding woes of local governments and the imperative for the public sector to support business activity, the issuance of local government bonds earmarked primarily for infrastructure development has lagged far behind schedule, and restrictions on local government funding and investments have barely eased," Yan Wang, chief emerging markets and China strategist at Alpine Macro, told clients in a recent note.

From January to August, roughly 5.4 trillion yuan of local government bonds, equivalent to about $760 billion, were issued, a 14% decline from a year earlier, according to figures from data provider Wind.

The slow progress can be explained, at least in part, by authorities’ concerns around debt risks and a lack of attractive projects to invest in after a decadeslong infrastructure boom. However, at a time of heightened disinflationary pressure and faltering demand from Chinese households and corporations, economists say the government sector needs to step up and borrow more aggressively to fill the gap and prop up inflation, which in turn could encourage people to spend more.

“Although exports may provide a strong boost to GDP growth this year, we believe more fiscal easing is necessary to help secure the ‘around 5%’ full-year growth target," economists at Goldman Sachs wrote in a note on Sunday. One low-hanging fruit is to accelerate government bond issuance, they said.

During the first seven months of 2024, China’s tax revenue fell 5.4% from a year ago, while local government proceeds from land sales slid more than 20%, official data showed.

For Luo Zhiheng of brokerage firm Yuekai Securities, declining tax and land income and limited government debt borrowing have combined to weigh on the expansion of fiscal expenditures, making it difficult to support the economy effectively.

Luo called on Beijing to rethink its insistence on the 3% deficit rate that authorities have long regarded as a red line for fiscal discipline. Such a ratio isn’t an “iron rule," with European countries and the U.S. breaking through that limit during the global financial crisis, Luo said in a note this week.

Apart from issuing extra treasury bonds, other ways to allow fiscal policy to play a larger role in stabilizing growth include Beijing providing more financial support to local authorities and extending the timeline for clearing hidden debts to avoid pressuring the economy, Luo said.

However, some economists caution that even if the Chinese government borrows more now, it won’t offer a quick fix to the deeper economic malaise, and a meaningful rebound in the housing sector remains key to addressing China’s economic woes.

Amid evaporating land sales revenue and intensifying debt pressures, a growing number of local governments have become “grabbing hands" instead of “helping hands" by charging exorbitant fees, imposing frequent fines and excessively strengthening tax collection, economists at Nomura said.

Such a shift would undermine the foundations of China’s economic success, and Beijing should move decisively and provide direct funding to stabilize the property market, the root cause of the current fiscal tensions, Nomura’s economists said in a note.

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