China now seen facing ‘impossible challenge’ on budget, tax and GDP

A man rides a bicycle along the Bund while buildings of Pudong's Lujiazui financial district stand across the Huangpu River as the sun rises in Shanghai, China. (Photographer: Qilai Shen/Bloomberg)

CHINA is attempting to pull off an unusual fiscal feat: Cut taxes, boost spending and shrink the deficit, all with a slowing economy.

Premier Li Keqiang on Monday announced the first budget-deficit goal reduction since 2012, to 2.6 percent of GDP, from 3 percent. He also pledged tax cuts of 800 billion yuan ($126 billion) for companies and individuals and set a 6.5-percent annual economic growth target—the same as last year’s target but slower than the actual performance of 6.9 percent.

In the context of China’s multi-year effort to slow debt growth, a tighter fiscal budget sends a powerful signal—even the state is tightening its belt. But while Li used exactly that metaphor in his annual work report this week, policy-makers left some wriggle room by saying that the deficit target left space for “macro regulation.”

Cutting taxes while spending more and shrinking the deficit is an “impossible challenge,” said Freya Beamish, chief Asia economist at Pantheon Macroeconomics Ltd. in London. “These targets suggest tight monetary conditions and tight fiscal policy, with GDP growth holding up, despite an intensified deleveraging campaign,” she said. “Something’s got to give. We reckon it’s fiscal policy, though monetary policy could also turn out on the easier side, with the yuan also set to weaken.”


Resurgent producer-price inflation and robust nominal growth that have boosted corporate pricing power and profits since 2015 are both set to ease this year, making it harder for indebted companies to cut debt, Beamish said. “The government will have to continue with the same fiscal support as last year,” but also spend more and increase off-balance sheet borrowing, she said.

Alicia Garcia Herrero, chief Asia-Pacific economist at Natixis SA in Hong Kong, cites calculations  showing China’s revenues as a percentage of output clearly declining since 2015. That’s a trend that hasn’t had any obvious policy response, she said in an e-mail.

“The 2.6 percent does not look consistent with ample growth nor does it look achievable without fiscal reform,” she said.

“Squaring the circle of stable growth and reduced stimulus will be tough to do,” Bloomberg economists Tom Orlik and Fielding Chen wrote in a report. They forecast a slowdown
to 6.3-percent growth this year.

There are hidden channels to pump funds into the world’s second-largest economy if growth looks to be faltering too much. This stealth spending isn’t shown in the deficit ratio of the general public budget that’s released annually.

Leaders still plan to expand issuance of special purpose bonds, which are sold by local governments to finance items such as highways, railroads and other construction projects. The securities are designed to be covered by returns of the projects, not general revenue.

Special-purpose bond issuance will jump to 1.35 trillion yuan this year to prioritize “supporting ongoing local projects to see them make steady progress,” the Finance Ministry said Monday. That’s up from 800 billion yuan in 2017 and 400 billion yuan in 2016.

“While the general public budget deficit ratio is lowered, the deficit ratio covering all government accounts is largely stable,” Liu Liu, an analyst at China International Investment Corp. in Beijing, said in a note. The combined deficit of general public budget and government-managed fund budget could rise to 4.1 percent of GDP this year, from 4 percent last year, Liu wrote.


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Turning Points 2018