Tag Archives: fiscal policy

China’s Debt Hits Close To Home

THIS BYSTANDER HAS been far from alone in highlighting the tightrope that China’s policymakers have to walk between stimulating growth and accumulating more debt as they manage the structural slow down of an economy switching from industrial to services-led growth and facing adverse demographic changes.

Thanks in  part to the People’s Bank of China (PBOC)’s counsel of restraint, driven by the central bank’s twin concerns of the debt bubble bursting and inflation getting out of hand and its measured but steadfast drive for financial sector liberalisation, Beijing has been selective in its stimulus measures to keep a slowing economy expanding at a sufficient pace to hit the official 6% GDP growth target for this year and the larger one of doubling total and per capita GDP between 2010 and 2020.

While the plan has always been to manage a slowing of the economy as it rebalances towards a more sustainable long-term growth model, the impact of the trade and technology disputes with the United States on world trade have put at risk the 5.5-6.0% growth China needs to achieve in 2020 to hit the overarching decade-long goal.

Earlier this month, the central bank cut its lending rates for the first time in three years. The cuts were a token five basis points for the five-year, one-year and seven-day loan rates. There remains plenty of headroom for further monetary stimulus, but not the appetite, on the central bank’s part at least, to occupy it.

Taking a barb at the United States, PBOC Governor Yi Gang said in September that “unlike central banks of some other countries, we are in no hurry to resort to a considerable interest rate reduction or QE policy”. Yi is keeping his powder dry, in the event that significant rate cuts do become necessary to provide monetary stimulus. Yet his priority is to deleverage the economy, or at least in current circumstances to maintain a “stable leverage ratio…to ensure the debt sustainability of the entire society”, as he put it at the same press conference.

In its latest annual financial stability report released this week, the PBOC gave a stark warning about the potential systemic risk in the buildup of household debt, whose total now equals total household income. One figure that caught this Bystander’s eye was the central bank saying that household leverage had hit 60.4% of GDP at the end of 2018. The Bank for International Settlements had pegged the ratio at 54% (four percentage points higher than in the EU, by way of comparison).

The PBOC is particularly concerned about the growth of mortgages and consumer loans. It has warned previously of the buildup of corporate and local-government debt, but turning its spotlight on household debt is a notable change of focus. Easing of mortgage lending standards to boost property investment and the use of consumer credit to increase retail sales have been the main stimuli of growth in recent years. Rising household incomes make the rise in consumer loans manageable for now, although further buildups would test that assumption, especially among low-income households.

A new IMF working paper on China’s household debt notes that

High household indebtedness could constrain future consumption growth and increase financial stability risks…we find that low-income households are most vulnerable to adverse income shocks which could lead to significant defaults. Containing these risks would call for a strengthening of systemic risk assessment and macroprudential policies of the household sector. Other policies include improving the credit registry system and establishing a well-functioning personal insolvency framework.

Regardless, further consumer-focused fiscal stimulus is likely, perhaps a second income tax to follow last year’s 420 billion yuan ($59 billion) one, and the reintroduction of subsidies for electric and hybrid vehicles.

It is the rise in mortgage loans that more concerns PBOC policymakers. Mortgages account for more than half of all consumer debt. There is evidence that they are inflating a speculative bubble, as well a making affordable housing a politically sensitive issue. Nearly two-thirds of outstanding mortgage debt is accounted for by families owning at least two properties. Some of last year’s tax cut has gone into savings rather than retail consumption, with the saving being in the form of property investment.

This all comes against the background of the crackdown on shadow banking, which included unlicensed digital-payments businesses, online lending and other internet finance companies, in the process shutting down all cryptocurrency trading platforms and more than two-thirds of online peer-to-peer lending platforms.

This has split over into the formal banking sector. Three regional banks, Baoshang Bank, Hengfeng Bank and the Bank of Jinzhou, have needed bailouts this year. Up to 30 more have been late in filing financial accounts required by regulators, suggesting further bailouts to come. In addition, corporate bond defaults this year will likely exceed last year’s record.

The ‘big-four’ state-banks are financially robust enough that any such losses can be absorbed without systemic risk. However, having spent several years engineering higher bank asset quality and lending standards, the PBOC will not want to put the big banks in the position of having to underwrite other institutions’ bad debts. Yi has been clear that any can carrying at a troubled financial institution should be done by its shareholders, not the state via the big-four banks.

Part of the exercise in risk management will require financial-markets reform and further opening to foreign investors. China has moved steadily but cautiously on that. The addition of Chinese stocks to MSCI’s benchmark indices and the likelihood that other index providers will follow suit, adds new urgency.

The changes will bring an inflow of foreign capital into Chinese equities of at least $40 billion this year and, on best guesses, a further $30 billion in 2020. That will provide a welcome influx of capital, particularly for companies in the private sector. It will also offer some relief for a central government whose consolidated deficit, the IMF forecasts, will grow to 6.1% of GDP this year and next, from 4.8% of GDP in 2018. As the late US banker Walter Wriston famously said, “capital will go where it is wanted, and stay where it is well-treated.”

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Short-Term Stimulus Trumps Long-Term Risk

THERE IS MUCH to digest in the official reports of the annual Central Economic Work Conference just concluded in Beijing.

In short, every available policy tool will be thrown at stabilising slowing growth in the short-term while attempting to keep a clear eye on the long term goal of rebalancing and deleveraging the economy and establishing China’s greater role in global economic governance, the unstated part being that the successful execution of the long-term plan is what will ensure the Party’s continued monopoly on power.

For now, keeping the economic ship stable in turbulent waters in 2019 will demand bigger tax cuts, no tightening of monetary policy and easing as needed, particularly to keep liquidity flowing to small and medium-sized enterprises in the private sector, and a significant expansion of special-purpose local government bond issuance to pay for the old stimulus standby, more infrastructure investment.

This all adds up, if not to a full-blown stimulus package then at least a considerable expansion of this year’s targeted measures.

The downside is that it will slow the long-term structural reforms needed to move the economy up the development ladder and to defuse the country’s underlying debt bomb. The trade tensions with the United States are lengthening the fuse, and that may do more damage to the economy than tariffs themselves.

Deleveraging the economy while simultaneously stimulating it is a difficult balancing act, and the more so in a global economic environment that is more unpredictable and unfavourable to Beijing that any recent leadership has experienced.

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VAT And China’s Other Taxing Problems

CHINA STARTED TO replace its Business Tax with a value-added tax (VAT) in 2012 when a pilot scheme was launched in Shanghai. VAT has since been steadily expanded, both geographically and sectorally.

Earlier this month, following an executive meeting of the State Council, chaired by Prime Minister Li Keqiang, plans were announced for streamlining the administration of VAT and acknowledging that it has become a universal national tax.

The service sector first saw the tax in May last year when it was applied to property, financial and consumer services sectors. At the same time, VAT was extended fully nationwide.

Authorities say that between then and June, the switch to VAT has saved businesses 85 billion yuan ($12.8 billion) in taxes, providing an important boost to the ‘rebalancing’ of the economy towards consumption. Total tax savings since the pilot scheme started is put at 1.6 trillion yuan.

In July, the four VAT brackets (17%, 13%, 11% and 6%) were reduced to three with the elimination of the 13% bracket. Agricultural products, tap water, publications and several other ‘13%’ goods were moved down to the 11% bracket, though that still leaves more VAT tiers than the international average.

The new plans foresee digitization of the tax system, simplifying procedures for tax filing and switching from physical to electronic versions of the invoices-cum-receipts (fapiao) that serve as legal proof of purchase for goods and services. Fapiao are a key component of enforced compliance with China’s tax law as they compel companies to pay tax in advance on future sales.

The VAT fapiao is also used for tax deduction purposes within VAT, so digitising the whole process should streamline the accounting.

The tax is still referred to as “the VAT reform pilot program” though that status as a pilot looks like ending de jure as well as de facto; the State Council executive meeting also indicated that more detailed national VAT legislation would be forthcoming.

There is more work to be done on standardising it as a national tax. There are still inconsistencies between sectors in the rates applied to the same goods and services. Also, some tax payers are not able to make full VAT deductions. A further issue to address is compliance costs for taxpayers with multiple business locations.

One major issue that a national VAT does not address is how the tax take is shared at the provincial level. (Germany and Japan, for example, use allocation rules based on population and aggregate consumption, respectively.)

However, China has a bigger problem of fiscal redistribution to tackle. The country has the largest share of local government spending in the world, largely because public services and the social safety net (health, education, welfare, etc.) are centrally mandated but delivered and paid for at the local level. Many federal countries decentralise their social insurance system, but China is a rarity in having both its public pension system and unemployment insurance managed at the local level.

Yet, since the fiscal reforms of 1994, provinces and municipalities have negligible revenue raising powers of their own. Further, although 60% of taxes are collected by local government, those taxes are handed over to central government with some to be returned via revenue-sharing and other transfer schemes through rules that are still not completely transparent.

Transfers from the central government were supposed fully to finance local-government deficits since provinces and municipalities were barred from issuing debt.  In practice, however, local governments were given increasingly large unfunded mandates. Because of the prohibition on issuing debt, they resorted to selling land and using off-budget special-purpose vehicles to borrow and spend on infrastructure, starting the infamous local-government debt bomb ticking.

Local governments debt had reached the equivalent of around 40% of GDP by 2015.

A fiscal reform plan was announced in 2016 to address the misalignment, but it will take a comprehensive imposition of taxes such a market-value-based property tax, local surcharges to personal income tax and maybe even an additional provincial-level VAT — though that is difficult technically to administer; few if any countries have pulled it off.

It will also mean converting the pilot scheme for issuing and trading municipal debt started in 2014 when back door borrowing through special-purpose vehicles was banned, into a national muni-bond market. That, in turn, will require broader financial-system reforms.

Those are proceeding at a cautious, measured pace. Short-term stability and state-centric control is the current leadership’s instinctive approach. That may change after the forthcoming Party congress, but, more likely, it will not. In that context, streamlining VAT to puts greater taxation capacity in Beijing’s hands makes political as well as economic sense.

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Steady As She Goes For China’s Economy In 2013

China’s annual two-day closed door economic policy-setting conference has concluded with a cautious weather eye again being cast to the squalls of the global economy next year. Policy will be kept as is, not unexpectedly, but with room for maneuver in both fiscal and monetary policy reserved should the global economy deteriorate.

Rising protectionism, inflation and asset bubbles are listed as the main risks along with the longer running lack of demand in China’s export markets in the rich countries. Beijing will target 7.5% GDP growth for 2013, the same as this year. Monetary policy will remain modestly expansive, with a hand being kept on the bank lending and public spending taps ready to open or close them a turn as necessary. Property controls will remain and the yuan held steady.

The conference seems to have said all the right things about economic reform. The country will push forward with the next stage of economic reforms “with greater political courage and wisdom,” state media reported. That, though, is more difficult to deliver than economic targets.

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China’s Falling Inflation Still Demands Policy Caution

April’s consumer price inflation numbers released Friday follow weak trade and industrial production figures that all point to the slowdown in China’s economy continuing. The question is whether that slowdown is running to plan, or whether it is slowing more rapidly than the authorities would like, and thus requires a policy response to stimulate growth.

Outside commentators are leaning increasingly towards expecting that given the recent sets of monthly economic indicators, particularly those for inflation. The consumer price index (CPI) came in at 3.4% for April, down from March’s 3.6% and below the government’s 4% target for the third consecutive month. Yet, to this Bystander, the central bank’s warning earlier this week that inflation is falling but not yet stable suggests authorities will continue to be cautious about loosening monetary or fiscal policy.

The chain reaction that would cause a hard landing to the economy is a property bubble burst causing the local government debt bubble to burst, triggering a banking crisis, triggering a financial crisis, triggering an economic crisis, triggering a social crisis. Managing down the property bubble, as the first line of defense, has been the policy priority.  It has has some success in lowering home prices and reining in speculative building. Year-to-date property investment, at 18.7% is down from 34% in the same period a year earlier. But that growth rate still shows how much more there is to do.

If that doesn’t provide policymakers with reason for caution, then the suicide bombing of a government office in Yunnan earlier this week over an allegedly uncompensated land seizure, unusually prominently reported if only the most dramatic of increasingly common violent protests over land evictions, provides them with a stark and tragic reminder of what lies at the other end of the chain if the property bubble isn’t let down in a controlled way.

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April’s PMI Points To China’s Growth Slowdown Moderating

The flash (preliminary) HSBC purchasing managers’ index (PMI) for April came in at a two-months high of 49.1, 0.8 points higher than the final reading for March and reversing a five-months decline. Any number below 50 signals contraction; above, expansion. So factory activity remains sluggish, but not as sluggish as in recent months.

The HSBC index is weighted towards export-dependent small- and medium-sized manufacturers, and usually shows a lower number than the official PMI, which better reflects the activity at large companies.  The April number suggests that the increased bank lending that the central bank has allowed over the past month or so, even for small companies, is having some effect on moderating the slowdown in growth. The contraction in new orders is slowing and exports orders increase to a three-months high reflecting the modest recovery being seen in the U.S.  Even though the latest PMI figure will helping to ease concerns of a sharp slowdown in growth, we expect the central bank to remain measured about further easing of both monetary and fiscal fronts.

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China Formally Switches Monetary Policy To What It Already Is

The newly announced switch from the current “moderately loose” monetary policy to that old favorite, “prudent”, next year is no more than a formal anointment of what has been going on for months: the withdrawal of the 4 trillion yuan ($600 billion) monetary stimulus to combat 2008’s global financial crisis to be replaced by the 2010 focus on the battle against inflation. The statement followed a Politburo meeting reviewing the new 5-year plan that starts next year.

Easy credit led to a lending boom that the central bank is now striving to rein in through reduced loan quotas, interest rate hikes and increases in banks’ reserve requirements. At the same time it has been introducing measures to reduce the demand for property, the final destination of much of the new lending. Yet inflation hit a 25-month high of 4.4% year-on-year in October and is expected to have been higher in November, way above the target of 3% and despite moves to reverse food price rises which account for about a third of the inflation number.

The brakes are being applied but not too abruptly. Growth has been slowed to 9.6% year-on-year in the third quarter, down from 10.3% in the second and 11.9% in the first. Beijing won’t want to see the economy decelerating for much longer, and will want to see it remaining robust enough to absorb further interest-rate rises and increases in banks’ reserve ratios. The Politburo left policymakers plenty of room to fine tune: macro-regulation should be more “targeted, flexible and effective” while fiscal policy  should be “proactive”, the statement said. Proactive fiscal policy might just mean the introduction of a property tax, as a new IMF Working Paper recommends.

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China’s Economy in 2010: Steady And Uneasily As She Goes

This year’s Economic Work Conference, the annual top-level economic policy meeting, was as much about politics as economics, though that can be said most years. Creating socially stabilizing jobs was the focus, not that China is alone in that, and particularly rural jobs to absorb the migrant labor left jobless by the slump in the export manufacturing sector.

Few concrete policy details have emerged from the closed door meeting yet; they rarely do immediately but there was a broad commitment to keep the stimulus going in what will be the final year of the current five-year plan and last full year of the Hu-Wen leadership. Monetary policy will be kept loose, despite the central bank having being gently reining that in for some months. Fiscal policy will be “proactive”, which presumably means an extension of tax breaks that have been so beneficial to industries such as car making and to a lesser extent export manufacturers. In particular, more public money will be pumped into the countryside to raise demand there and thus the need for local jobs.

But as a sign of the fragility of the reaccelerating of growth seen this year, industries suffering from overcapacity will continue to see excess production capacity stripped out, under the guise of modernization and consolidation, much as we have been seeing with energy intensive and polluting industries over the past several years. New industrial investment will be kept “moderate”, according to Xinhua‘s post-meeting report.

If anything, industrial overcapacity is getting worse, especially in steel and cement making. That is not what should be being seen if recovery was on a solidly sustainable footing. And it goes to the heart of the problem China faces in growing its way out of a slowdown through investment spending, the central planner’s go-to policy response.

It is unsustainable and becomes an increasingly inefficient way to grow. Other countries might end up building bridges to nowhere, but in China state spending flows through state-controlled banks to state-owned enterprises and thus potentially deflationary industrial overcapacity.

Switching spending from investment to consumption, as we have noted before, is no easy task. Joblessness is one of the political costs of not being able to do so. Next year will see more expensive tending to the symptons and not enough curing of the underlying disease. Investors haven’t priced that into equities yet, but they will, possibly the hard way.

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