Six Q&As on why China's largest debt package in years might be underestimated
Do misconceptions around the package hold water？How to understand the significance of the package in driving China's economic growth?
China's largest debt package in years unveiled recently has come under the limelight, as the government moved to increase the debt relief resources for local governments by 10 trillion yuan (about 1.4 trillion U.S. dollars) to reduce the amount of hidden debts they need to deal with by 2028 by a massive 12 trillion yuan. While some have still raised questions about the impact of this package, there are strong arguments against misconceptions that might lead to an underestimation of its potential effects.
This article cites Liu Yuanchun, president of the Shanghai University of Finance and Economics, on CCTV, Luo Zhiheng, chief economist of Yuekai Securities, in a Yicai report, and Shen Jianguang, chief economist of JD.com in his column article on FT Chinese to present a more comprehensive view of the debt package and its significance in driving China's economic growth.
Backgrounder (From Xinhua):
Chinese lawmakers approved a State Council bill early this month on raising the ceiling on local government debt by 6 trillion yuan to replace existing hidden debts. Under the new arrangement, the debt ceiling for special local government debt will be increased to 35.52 trillion yuan from 29.52 trillion yuan by the end of 2024.
Also starting from 2024, China will set aside 800 billion yuan from each year's new special-purpose bonds for local governments for five consecutive years, thereby providing debt relief to replace 4 trillion yuan of hidden debts.
The new measures will add a combined 10 trillion yuan to China's debt relief resources.
Meanwhile, the 2 trillion yuan of hidden debts resulting from housing improvement projects in run-down areas due by 2029 and beyond will be paid in accordance with the original contracts.
As a result, the amount of hidden debts that China's local governments need to deal with by 2028 is expected to drop from 14.3 trillion yuan to 2.3 trillion yuan.
Question 1: Is the scale of the debt package sufficient for the Chinese economy?
Luo:
The 12 trillion yuan debt package was above the predictions of many market institutions, whose estimations for the scale varied between 2 trillion yuan and 10 trillion yuan. As the largest debt package in recent years, it has addressed the primary task in the economy -- to greatly arouse the capability and enthusiasm of local governments in supporting the economy and improving people's livelihoods, which is a major recipe for China's economic growth.
With the fast implementation of the debt package, along with other incremental fiscal measures, the proactive fiscal policy will have an even bigger impact that can be multiplied to help the economy recover.
Shen:
The first and foremost misconception surrounding the debt package is believing that its volume is insufficient. Such a viewpoint fails to fully grasp the overall picture of the comprehensive set of incremental fiscal tools. Finance Minister Lan Fo'an has clearly stated that more special-purpose bonds will be issued in 2025, which could make up for the 800 billion yuan allocated annually for debt replacement; the 2 trillion-yuan hidden debts to be repaid in a later time could be understood as an additional issuance of bonds with a maturity of four years for debt replacement. From this perspective, the 12 trillion-yuan scale of debt replacement is substantial. As one of the main arrangements of the incremental fiscal policy measures, the debt replacement, which accounts for about 10 percent of China's GDP, is not insignificant. If we take into account other policy tools apart from the debt replacement, China's recent incremental fiscal policy measures are nothing short of a bold and ambitious move.
Question 2: Does the package prioritize helping the government over supporting enterprises and residents?
Liu:
The current debt replacement plan reduces the burden on local governments, meets a basic precondition for the functional restoration of local governments, and provides funding space for the expansionary policies of local governments, which is very important. Only after the local government funds are in place can we carry out the construction of some livelihood projects and provide active fiscal support for a series of incremental policies that have been arranged, which will have a direct impact on enterprises and residents.
At the same time, this debt package will allow enterprises and individuals previously owed hidden debts to quickly obtain funds without defaults and restore their fund flows and business operations to normal conditions. This will also play an indirect role in boosting employment and income growth.
Shen:
The criticism that the debt replacement scheme provides respite to the government's urgent needs but neglects the interests of enterprises and residents fails to understand the broad impact of local governments' fiscal constraints on enterprises and residents. A large number of enterprises and residents could see a direct impact on their income from local governments being forced to reduce public investment and procurement, expenditures on government services such as health care and education, as well as transfer payments.
According to data from the National Bureau of Statistics, government consumption accounts for about 30 percent of China's total final consumption. In my estimation, fiscal funds also have a direct influence on around 30 percent of infrastructure investment. The large-scale debt replacement relieves the cash flow pressure of local governments, which is beneficial for the restoration of general government expenditures. It also helps address the problem of arrears of payment to enterprises and civil servants and can further drive income restoration for enterprises and residents through the multiplier effect.
Question 3: Does the package prioritize investment over consumption?
Shen:
Firstly, improving local government expenditures is significant for boosting government consumption in areas such as health care, education, and government procurement and for improving retail sales of consumer goods. Secondly, tackling payment arrears for enterprises and salary arrears for civil servants also contributes to income growth for residents, which in turn stimulates consumer spending. Thirdly, with a further expansion of the room for the fiscal deficit next year and increased support for the consumer goods trade-ins, the current consumption strength could be sustained in sectors such as household appliances and automobiles for a longer period. Lastly, the increased transfer payments and a better guarantee of spending on people's livelihoods in 2025 will reduce the need for precautionary savings among residents and stimulate consumption.
Question 4: Does the debt package equate with a stimulus for the economy?
Liu:
As a debt replacement scheme, this package is not so closely related to the increased fiscal spending or faster monetary support that some had imagined before its announcement. To a greater extent, it aims to make adjustments regarding risk control and reform.
It can help local governments ward off crises and defuse risks and provide funding room for future moves to expand the domestic demand and implement the proactive fiscal policy. It also offers sound support for local governments to boost liquidity. In the meantime, the scheme stresses reform of the local government investment and financing vehicles and restructurign of the debt management system, which is in line with the fiscal and taxation system reform tasks put forward by the third plenary session of the 20th Communist Party of China Central Committee.
Therefore, it can not be simply viewed as part of a stimulus, but has a foundational role in lifting domestic demand, advancing reform and controlling risks. It is more than just a stimulus policy.
Question 5: Will the package lead to excessive inflation?
Liu:
The funds for debt replacement is raised through the issuance of local government bonds and special-purpose bonds. This debt replacement is not the same as printing money. In fact, it is about raising funds on the financial market and meeting the urgent needs of local development to promote economic expansion after the replacement. In the current economic environment with production overcapacity, excessive supply and insufficient demand, an appropriate increase of monetary supply and fiscal outlays will not bring about the inflation that some have feared but put the economy onto the normal track.
Question 6: Will the package bring new debt risks?
Luo:
The debt replacement has basically made hidden debts explicit, with most local government debt becoming more transparent and regulated, which in itself is a process of reducing risks for easier scrutiny.
Liu：
China's finance minister has stressed broader scope of monitoring, stronger budget constraints, and stricter regulation and accountability to beef up oversight on new hidden debts. These are all very important measures that can be taken now. We must draw some lessons from the past decade of debt relief practices. The accumulation of new hidden risks results from the mismatch between the fiscal and administrative powers, the improper positioning of local governments' functions, and the asymmetry of rights and obligations. All these make it necessary to reform the fiscal and taxation systems and reorient the functions of governments, particularly local governments. This is the fundamental solution.
By Wang Hongjiang and Wang Wen