China turns fiscal screws while maintaining 6.5-percent red line on gross domestic product

China stepped up its push to curb financial risk, cutting its budget-deficit target for the first time since 2012, and setting a growth goal of around 6.5 percent that omitted last year’s aim for a faster pace if possible.

The deficit target—released on Monday as Premier Li Keqiang delivered his annual report to the National People’s Congress in Beijing—was lowered to 2.6 percent of GDP, from 3 percent in the past two years. The 6.5-percent goal is consistent with President Xi Jinping’s promise to deliver a “moderately prosperous” society by 2020.

Policy-makers dropped a target for M2 money-supply growth, saying it’s expected to expand at similar pace to last year. Authorities reiterated prior language, saying prudent monetary policy will remain neutral this year and that they’ll ensure liquidity at a reasonable and stable level.

Xi has ratcheted up his drive to curb debt risk, pollution and poverty at a time when the world’s second-largest economy is on a long-term growth slowdown. His efforts to rein in spending contrast with a historic expansion of United States borrowing under Donald J. Trump during a period of economic expansion.

The 2018 targets “suggest slower growth and a fiscal drag,” said Callum Henderson, a managing director for Asia Pacific at Eurasia Group in Singapore. “This makes sense for China in the context of the new focus on financial de-risking, poverty alleviation and environmental cleanup, but is less good news at the margin for those economies that have high export exposure to China.”

Growth handily surpassed 2017’s target with a 6.9-percent expansion that was the first acceleration since 2010. Economists forecast a moderation to 6.5 percent this year, amid the ongoing deleveraging drive and trade tensions with the Trump administration and a further deceleration to 6.2 percent in 2019.

What our economists say:

“Li’s plan for the year is consistent with a moderate slowdown in real growth,” Tom Orlik, chief Asia economist at Bloomberg in Beijing, wrote in a  note. “With off-balance sheet borrowing by local governments already slowing, the prospect of a smaller budget deficit means China faces a substantial fiscal drag. Nor will monetary policy provide much support—with Li’s report flagging M2 growth steady from 2017.”

“We will improve the transmission mechanism of monetary policy, make better use of differentiated reserve ratio and credit policies, and encourage more funds to flow toward small and micro businesses, agriculture, rural areas, and rural residents, and poor areas, and to better serve the real economy,” Li said in his report.

Spending to curb pollution will rise 19 percent as authorities strive to make greater progress on one of their key objectives, Li added. Authorities aim to cut sulfur dioxide and nitrogen oxide emissions by 3 percent and keep reducing smog in key areas. Days with heavy air pollution in key cities have fallen 50 percent over the past five years, according to the work report.

The lower fiscal budget-deficit ratio goal should be seen in the context of the government’s awareness of the risk to systemic stability amid the deleveraging drive, said Pauline Loong, managing director at research firm Asia-Analytica in Hong Kong. “The work report this year is focused throughout on risk management.”

Growth will be supported by 800 billion yuan of tax cuts for enterprises and individuals, while use of special purpose bonds will prioritize “supporting ongoing local projects to see them make steady progress,” the Finance Ministry said.

Still, the augmented fiscal deficit, which includes local government financing vehicles and other off-balance-sheet activities, will remain expansionary at about 10 percent of GDP this year, estimates Liu Li-gang, chief China economist at Citigroup Inc. in Hong Kong. That’s down from the International Monetary Fund’s estimate of 12.6 percent last year.

“The recent pace of fiscal stimulus is unsustainable and unnecessary,” said Stephen Jen, CEO of Eurizon SLJ Capital Ltd. in London. “A curtailment in the official fiscal and growth target makes sense.”

Other key economic objectives included:

  • Retail sales growth of about 10 percent.
  • Consumer prices will rise about 3 percent, the same as last year’s ceiling.
  • Creation of 11 million new urban jobs, the same as last year.
  • Yuan exchange rate to remain stable at an equilibrium level.

The report also said that an increase in the thresholds for personal income taxes was planned.

Other 2018 objectives included:

  • Cut energy use per unit of GDP by more than 3 percent, versus 3.4- percent goal in 2017.
  • Steadily push forward legislation for a property tax.
  • Keep registered urban unemployment rate under 4.5 percent, unchanged from 2017.
  • Cut about 30 million tons of steel capacity, compared with 50-million ton goal last year.
  • Defense spending is expected to rise 8.1 percent, the quickest pace in three years.





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Turning Points 2018