To counter downward pressure on its economy, China has taken incremental fiscal measures including slashing taxes and stepping up fiscal spending, which have unwillingly contributed to the growing fiscal strains, especially for some local governments. To tackle the fiscal dilemma, China still has several ways to mobilize the existing government funds, and we have identified three main sources, namely higher dividend revenue from SOEs, relaxing local funding restriction on key projects, and utilizing other available government funds. These sources should be sufficient to fill the fiscal gap of 2019 without raising fiscal deficit ratio.
- Supportive fiscal policies push fiscal deficit to record highs. In Mar 2019, China decided to lift its target budget deficit ratio to 2.8% from 2.6% in 2018. We estimate China’s actual fiscal deficit to GDP ratio to reach a record high of 5.1% this year. Medium-scale fiscal deficit ratio has hit 4.7% in 2018 and is expected to reach 6.8% of its GDP in 2019, showing that China has reacted quickly to a sharper slowdown in growth.
- Widening fiscal gap may squeeze budgets. Fiscal revenue growth declined year-to-date and increased fiscal strains have begun to hamper fiscal expenditure. We estimate fiscal gap to reach RMB 240.2bn in 2019.
- China’s current fiscal dilemma: If government holds the current budget deficit target ratio constant, the slowing fiscal revenue growth is likely to hamper the ability to implement infrastructure projects and ultimately undermine government’s capacity to support the broader economy. On the other hand, if the government raises its deficit target ratio and increases issuance of local government debt, it will raise public debt ratio and take up the policy room of next year in advance.
- Three ways China can tackle its fiscal dilemma. With budget deficit ratio unchanged, China still has lots of fiscal policy room if downward pressure on growth continues in 2H19. Among the available sources of public financing, we have identified three feasible ways in this report: (1) To increase SOE dividend paid to government. China’s SOEs have relatively lower dividend payout ratios compared to those in other regions of the world. The effort to increase dividends paid by SOEs is expected to provide Chinese central and local governments with at least hundreds of billions of revenues. (2) To leverage support for infrastructure construction by the new rules. In Jun 2019, the government has loosened rules on local infrastructure financing and the remaining RMB 460bn new local government special-purpose bonds are expected to mobilize additional RMB 138bn to RMB 172.5bn investment for infrastructure. (3) To use existing government funds. Budget Stabilization Fund, Reserve Fund and local governments’ Carryover and Surplus Funds have around RMB 150bn, 145bn and 50bn available respectively.
- Conclusion: China’s fiscal stimulus will continue to play a proactive role in supporting growth. To deal with the pressure on local governments due to the economic slowdown, tax cuts and surging expenditure, China still has enough fiscal policy tools to fill the fiscal gap and achieve growth target. In addition to the three sources discussed in this report, raising the ceiling on local government debt is still one of the options.
