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• 2024-06-11

Expecting Fiscal Policy Breakthroughs: Government Debt as a Necessary Measure

On September 26th, the Central Political Bureau meeting emphasized the need for "intensifying the introduction of incremental policies" and "increasing the counter-cyclical adjustment efforts of fiscal and monetary policies." The market's expectations for fiscal policy to take action have further heated up, which also supports the continuous warming of the current sentiment. It is not only a positive guidance for expectations, but also from the perspective of policy effects, to fundamentally solve the problems of insufficient confidence, weak demand, and credit contraction, it indeed requires fiscal policy to make greater breakthroughs, forming a synergistic effect with monetary easing to amplify the composite effect. The key to the current fiscal policy's efforts lies in playing the role of government debt well, achieving a reasonable growth in "quantity," that is, adapting to economic growth, while also effectively improving "quality," grasping the "two keys."

1. Fiscal policy should play a more important role in counter-cyclical regulation

Recently, the central bank and other financial regulatory authorities have introduced unprecedented loose monetary policies, launching multiple initiatives to boost market confidence, and the market has responded positively. The Central Political Bureau meeting on September 26th further made a more comprehensive deployment, emphasizing the need for "intensifying the introduction of incremental policies" and "increasing the counter-cyclical adjustment efforts of fiscal and monetary policies." The market's attention and expectations for fiscal policy to take action have noticeably increased. I believe that this expectation has also become an important factor supporting the continuous warming of the current market sentiment, and the market's positive response may further continue in the short term. It is not only a reasonable guidance for expectations, but also whether the improvement of sentiment can be substantially transmitted to the fundamentals, or truly form a positive feedback, which离不开fiscal policy's further efforts to play its role in counter-cyclical regulation.

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Generally speaking, monetary policy mainly affects the economy by adjusting interest rates and the money supply, solving more flow problems, with relatively limited effects in distribution and other aspects. Moreover, as the long-term growth of money supply continues, its marginal effect on driving economic growth gradually "dulls." The additional GDP brought by each additional yuan of money supply has dropped from 0.6 yuan in 2011 to 0.19 yuan in the second quarter of 2024. Some measures in the current loose monetary policy may not have an immediate effect on the current confidence and demand issues faced by the market. For example, the reserve requirement ratio reduction, which can be a guide for monetary easing under traditional circumstances, releasing long-term liquidity in a timely manner, now has little significance as a guide, and is even mostly "digested" by the market in advance. Its role in the core contradiction, that is, the transmission of loose money to loose credit, is very limited. The current difficulty is that market entities are actively reducing leverage, and operations such as reserve requirement ratio reduction cannot simply reverse this trend of "credit contraction."

Therefore, for the Chinese economy, which is still in the process of bottoming out in the cycle, and without substantial improvement in the fundamentals of investment and consumption entities, monetary easing is not a "panacea." To fundamentally solve the problems of insufficient confidence, weak demand, and credit contraction, fiscal policy needs to make greater breakthroughs. By strengthening fiscal expenditure to reallocate resources, forming a synergistic effect with monetary easing, amplifying the composite effect, and effectively offsetting the expenditure contraction of other departments, thus promoting demand from contraction to expansion, is the "long-term medicine" to solve short-term and medium to long-term economic problems.

2. A reasonable scale of government debt is an important basic condition for economic development

The key to fiscal policy playing a role lies in the larger expenditure of the fiscal sector. Fiscal expenditure depends on fiscal revenue, the basic source of which is taxation. However, it is unwise to expand taxes during an economic downturn. We need to turn our expectations to another source—government debt—and play its important role in counter-cyclical regulation.

For a period of time, whether the level of Chinese government debt is too high and whether the risks are controllable have become the focus of attention both domestically and internationally. Currently, China's economy is at the stage of bottoming out in the cycle, with a more severe and complex external environment, insufficient effective domestic demand, and the pain of new and old momentum conversion. The over-adjustment of the real estate industry also continuously increases local fiscal pressure, and market concerns about government debt, especially local debt risks, have further increased. The Third Plenary Session of the 20th Central Committee proposed the establishment of a long-term mechanism to prevent and resolve hidden debt risks. Under the requirements of enhancing risk awareness and bottom-line thinking, the country launched a package of debt resolution last year, which has achieved preliminary results. However, it is inevitable that some growth contraction effects have appeared. In the current context of increased pressure for economic development transformation, how to coordinate debt resolution and development, and build a long-term debt mechanism has become an important topic of concern.

At the same time, we must recognize that in the current special period of social credit contraction and forced economic restart, the liquidity of residents and enterprises is facing shocks and their strength is gradually weakening. It is unrealistic for the government sector to contract, and it is necessary to take on further responsibilities. Maintaining a reasonable debt scale is very necessary. In fact, there are some mixed voices in the market regarding the active expansion of government debt, because historical international financial crises and economic depressions usually consider over-indebtedness and high leverage as one of the basic factors leading to the crisis. However, looking at the current level of Chinese government debt, considering the broad debt scale mainly composed of central government debt, local government explicit debt, and financing platform debt as local government implicit debt, it is about 133 trillion, with a leverage ratio of about 100%. Compared with the G7 industrial countries in the world, it is only slightly higher than Canada and Germany, far lower than other G7 countries, especially Japan, the United States, the United Kingdom, and other countries. Therefore, for the current performance of China's economy, the proportion of government debt scale to GDP needs to break through some of the original red lines. The focus should not be too much on debt expansion, but to correctly understand and expect the engine role of government debt in counter-cyclical regulation. When other engines fail, government expenditure is used to compensate for the insufficiency of market expenditure, promoting demand from contraction to expansion.

3. Government debt cannot expand without limits, grasp the two keys to achieve "quality" improvementIn counter-cyclical regulation, government debt is an especially precious policy resource. It is crucial to value and utilize these debt instruments well and not to expand them without limits. It is necessary to achieve a reasonable growth in quantity, that is, to be in line with economic growth, while also effectively improving quality to avoid potential risks that may arise from the previous extensive growth model. On the basis of expanding the total volume, attention should be paid to the prevention of debt risks.

In this process, two keys must be achieved. The first key is to adjust the structure of debt, allowing the central government to leverage more and increase the issuance of government bonds. At the end of last year, the leverage ratio of China's central government was 23.8%, which is significantly low compared to the world's major economies. Whether it is the United States under a fiscal federal system or Japan, which combines fiscal centralization with local autonomy, the central government's leverage ratio exceeds 100%. The central government also bears more public expenditure responsibilities such as education, health, and pensions. In comparison, the consistency between the central and local governments in China is insufficient, with local governments bearing a large number of responsibilities. Last year, considering the large-scale central government transfer payments, the fiscal revenue coverage was only 86%. Moreover, the transfer payment chain is long, and there are some issues in budget preparation, fund use, and performance management. Under these circumstances, expanding the central government's debt and reasonably transferring local government debt to the central government can reduce debt costs, enhance the overall credit of China's government debt, and also reduce the burden on local governments, enhancing local vitality.

The second key is to adjust the use of debt. First, it should be tilted towards the residential sector, with the core still being to solve the problem of income sources and consumption willingness. Traditional Keynesianism emphasizes employment because it believes that by increasing employment, it can raise the remuneration of workers, who are the ultimate consumers, thereby stimulating demand and promoting economic growth. However, in the industrialization process, with technological progress and equipment upgrades, the demand for labor in the production process gradually decreases. Compared to the past, the organic composition of capital continues to increase. In the current public infrastructure construction, a large amount of modern equipment is used, resulting in a smaller proportion of workers. Relying solely on infrastructure projects is difficult to significantly improve employment. Moreover, as traditional infrastructure projects gradually become saturated and investment efficiency decreases, the use of government debt needs to be tilted towards the residential sector. Issuing cash subsidies is the most effective way to expand workers' income and increase consumer benefits in the short term and can be further studied. Second, it is necessary to solve the government's credit issues, especially the government's arrears to enterprises. This includes both arrears to private enterprises and state-owned enterprises. According to media reports, there are currently more than a hundred local governments listed as defaulters by local courts. These cases include arrears of construction payments, arrears of demolition and resettlement compensation, and arrears of project development costs, etc. From a certain perspective, these are all liabilities of local governments and can be repaid through the replacement of government debt instruments. This does not change the balance sheet and the total amount of debt, but the structure and form of the debt are optimized, which can effectively improve government credit and promote the improvement of these investment entities.