Calls for new China debt boom miss the big picture

Prominent Chinese economist Yu Yongding is kicking the Beijing hornet’s nest with calls for forceful fiscal expansion at a moment when President Xi Jinping’s team is veering in the other direction. Yu, a former top People’s Bank of China official who’s now with the Chinese Academy of Social Sciences, argues that the “key to success” lies in a policy shift to “use fiscal and monetary levers to respond to growth and price data. Should both growth and inflation be sluggish, fiscal and monetary expansion are in order.” In Yu’s telling, the severity of headwinds bearing down on China require, in particular, a potent burst of public spending to restore demand and defeat deflationary forces. Instead, he worries, Xi’s economic team is far too focused on “supply-side” remedies like tax cuts – and at the expense that China’s potential growth would suffer in the long run. “Though few Western observers would acknowledge this,” Yu explains, “supply-side economics is more influential in China than in the US.” Other than Nobel laureate Paul Krugman, it’s hard to imagine many serious observers agreeing with Yu’s fiscal and monetary expansion proposals – least of all, officials at the International Monetary Fund. Speaking in Marrakech on Tuesday, IMF chief economist Pierre-Olivier Gourinchas called for “forceful action by the authorities” on a variety of fronts, not just looser fiscal policy. Gourinchas argued that Xi’s team should “help restructure struggling property developers, to make sure that there isn’t any increase in financial instability, to make sure it remains localized in the real estate market and doesn’t spread out into the broader financial system and help restore confidence of households.” The suggestion here is that structural reforms and regulatory steps are needed to stabilize Asia’s biggest economy. Of course, the IMF’s take doesn’t preclude increased fiscal spending. At the same time Gourinchas was speaking at an IMF event in Morocco, Beijing telegraphed moves to raise its budget deficit for 2023, suggesting a new fresh stimulus will accompany Xi’s supply-side efforts to tame property markets. As Bloomberg reports, Beijing may issue upwards of 1 trillion yuan (US$137 billion) of additional sovereign debt to finance new infrastructure projects. That would hike China’s 2023 budget deficit above the 3% cap set in March. This move may cheer Yu, who worries that Xi’s inner circle is overly wedded to the debt-to-gross-domestic-policy provisions of the Maastricht Treaty, the founding accord of the European Union. It holds that the debt/GDP ratio can’t exceed 3%. In Yu’s telling, Beijing has “pursued a cautious fiscal policy,” while the People’s Bank of China has been “juggling too many objectives.” He lists them as “economic growth, employment, internal and external price stability, financial stability and even allocation of financial resources.” In particular, Yu says, the PBOC has had to respond to the cyclical changes in the housing price index. “If the index rises sharply,” Yu explains, “the PBOC pulls back the monetary-policy reins. More broadly, the PBOC has committed not to pursue ‘flood irrigation’ – that is, flooding the economy with liquidity – but instead to stick to a ‘precision drip-irrigation’ approach.” Thank you for registering! An account was already registered with this email. Please check your inbox for an authentication link. Yet, Yu argues, China “undoubtedly” could have been achieving “higher growth over the past decade with a more aggressive macroeconomic-policy approach.” He says that, “while it’s too late to change the past, China can still achieve a more dynamic future – but only if it implements a carefully designed fiscal and monetary expansion focused on boosting effective demand and, ultimately, growth.” Yu Yongding, academician and senior fellow, Chinese Academy of Social Sciences. Photo: Wikipedia Trouble is, such policies do more to treat the symptoms of China’s economic challenges, not the underlying causes. Yu is hardly alone in thinking China’s problem is not enough quick sugar highs. On Tuesday, Shanghai Banxia Investment Management Center, a leading mainland macro hedge fund, urged Xi’s team to create a market stabilization fund that props up stocks to end the “vicious cycle” undermining shares. Basically, fund founder Li Bei is seeking a return to direct market interventions of the kind deployed in 2015. In a WeChat post, Li wrote that “the key is to break the damages asset-price declines are doing to citizens, and their confidence.” But such quick and easy fixes do zero to strengthen China’s capital markets, financial infrastructure or corporate governance. Nor do they increase innovation, productivity or opportunities for disruption in an economy crying out for it. At the same time, loosening fiscal policy and bailing out markets won’t alter incentives for local governments to c

Calls for new China debt boom miss the big picture

Prominent Chinese economist Yu Yongding is kicking the Beijing hornet’s nest with calls for forceful fiscal expansion at a moment when President Xi Jinping’s team is veering in the other direction.

Yu, a former top People’s Bank of China official who’s now with the Chinese Academy of Social Sciences, argues that the “key to success” lies in a policy shift to “use fiscal and monetary levers to respond to growth and price data. Should both growth and inflation be sluggish, fiscal and monetary expansion are in order.”

In Yu’s telling, the severity of headwinds bearing down on China require, in particular, a potent burst of public spending to restore demand and defeat deflationary forces. Instead, he worries, Xi’s economic team is far too focused on “supply-side” remedies like tax cuts – and at the expense that China’s potential growth would suffer in the long run. “Though few Western observers would acknowledge this,” Yu explains, “supply-side economics is more influential in China than in the US.”

Other than Nobel laureate Paul Krugman, it’s hard to imagine many serious observers agreeing with Yu’s fiscal and monetary expansion proposals – least of all, officials at the International Monetary Fund.

Speaking in Marrakech on Tuesday, IMF chief economist Pierre-Olivier Gourinchas called for “forceful action by the authorities” on a variety of fronts, not just looser fiscal policy.

Gourinchas argued that Xi’s team should “help restructure struggling property developers, to make sure that there isn’t any increase in financial instability, to make sure it remains localized in the real estate market and doesn’t spread out into the broader financial system and help restore confidence of households.”

The suggestion here is that structural reforms and regulatory steps are needed to stabilize Asia’s biggest economy. Of course, the IMF’s take doesn’t preclude increased fiscal spending.

At the same time Gourinchas was speaking at an IMF event in Morocco, Beijing telegraphed moves to raise its budget deficit for 2023, suggesting a new fresh stimulus will accompany Xi’s supply-side efforts to tame property markets.

As Bloomberg reports, Beijing may issue upwards of 1 trillion yuan (US$137 billion) of additional sovereign debt to finance new infrastructure projects. That would hike China’s 2023 budget deficit above the 3% cap set in March.

This move may cheer Yu, who worries that Xi’s inner circle is overly wedded to the debt-to-gross-domestic-policy provisions of the Maastricht Treaty, the founding accord of the European Union. It holds that the debt/GDP ratio can’t exceed 3%.

In Yu’s telling, Beijing has “pursued a cautious fiscal policy,” while the People’s Bank of China has been “juggling too many objectives.” He lists them as “economic growth, employment, internal and external price stability, financial stability and even allocation of financial resources.”

In particular, Yu says, the PBOC has had to respond to the cyclical changes in the housing price index. “If the index rises sharply,” Yu explains, “the PBOC pulls back the monetary-policy reins. More broadly, the PBOC has committed not to pursue ‘flood irrigation’ – that is, flooding the economy with liquidity – but instead to stick to a ‘precision drip-irrigation’ approach.”

Yet, Yu argues, China “undoubtedly” could have been achieving “higher growth over the past decade with a more aggressive macroeconomic-policy approach.” He says that, “while it’s too late to change the past, China can still achieve a more dynamic future – but only if it implements a carefully designed fiscal and monetary expansion focused on boosting effective demand and, ultimately, growth.”

Yu Yongding, academician and senior fellow, Chinese Academy of Social Sciences. Photo: Wikipedia

Trouble is, such policies do more to treat the symptoms of China’s economic challenges, not the underlying causes.

Yu is hardly alone in thinking China’s problem is not enough quick sugar highs. On Tuesday, Shanghai Banxia Investment Management Center, a leading mainland macro hedge fund, urged Xi’s team to create a market stabilization fund that props up stocks to end the “vicious cycle” undermining shares. Basically, fund founder Li Bei is seeking a return to direct market interventions of the kind deployed in 2015.

In a WeChat post, Li wrote that “the key is to break the damages asset-price declines are doing to citizens, and their confidence.”

But such quick and easy fixes do zero to strengthen China’s capital markets, financial infrastructure or corporate governance. Nor do they increase innovation, productivity or opportunities for disruption in an economy crying out for it.

At the same time, loosening fiscal policy and bailing out markets won’t alter incentives for local governments to create more competitive business environments; build social safety nets, which are needed to get households to spend more and save less; or address the nation’s aging population.

Stimulus alone can’t hasten the transition to a demand-driven economy and away from today’s investment-heavy, state-owned-enterprise-led growth model. It won’t make foreign investors more confident to bet big on China. And it certainly won’t stabilize the shaky property markets that are spooking investors.

This property markets problem ranks above all else. Two years after China Evergrande Group defaulted, Country Garden is hinting it won’t be able to meet offshore obligations. The debt load of Country Garden, one of China’s biggest property developers, entered 2023 at an estimated US$196 billion.

“The property sector showed signs of weakening again, despite the raft of easing measures rolled out in September,” says Nomura economist Tu Ling. “This was especially the case in low-tier cities, which might be further squeezed by the easing of restrictions in high-tier cities.”

Zhang Wenlang, an analyst at China International Capital Corp, adds: “We think the pressure along the real estate value chain such as sales, land acquisition and construction may continue to weigh on economic growth.”

The scale of the problem has drawn comparisons to Japan’s bad loan crisis in the 1990s. Cleaning up the real estate sector requires “forceful action,” says IMF’s Gourinchas.

“If that doesn’t happen, then there is a chance that that problem could fester and become worse,” he says.

The PBOC will do its part, of course. But the weak yuan may limit Governor Pan Gongsheng’s latitude to slash interest rates further. That means some fiscal loosening seems inevitable.

“With CPI falling to deflation, exports contracting further and the property sector still struggling, we see incentive for the government to make full use of the fiscal space under the approved budget to stabilize growth,” says economist Ding Shuang at Standard Chartered Plc.

Economist Thomas Gatley at Gavekal Research notes that troubles facing Evergrande and other developers – going way beyond the stress they place upon the companies’ direct creditors – damage the Chinese economy broadly, “as the recent pullbacks in equity and offshore bond prices attest.”

Investors, Gatley says, have at least three reasons to be concerned about how the Evergrande situation plays out.

One, the risks of government policy error that “disrupts markets and the economy” have increased, he says. Gatley adds that “mistakes are always possible, and the fragile situation of developer finances makes the flow of events difficult to predict or control.”

Two, there’s still the “potential for additional damage to housing-market sentiment, which is already jittery.” Three, “the financial stress of property developers is spilling over onto other companies as developers delay or default on payments to their suppliers,” Gatley says.

China’s listed developers collectively owed 3.4 trillion yuan (US$466 billion) in trade payables to their suppliers as of the middle of 2023. Evergrande alone accounts for US$82 billion.

“In short,” Gatley says, “the travails of China’s real estate developers have already sucked trillions of renminbi of liquidity out of the economy — and if things get worse for developers, so will the financial drag on related industries.”

Hence the dire need for the supply-side revolution that economists like Yu downplay.

In Marrakech this week, another IMF official — fiscal affairs director Vitor Gaspar — came at the problem from another direction. Both China and the US, Gaspar says, are getting less bang for their stimulus buck.

“If you look at what is exactly driving the US and China, you would say it’s large and persistent budget deficits on the order of 6% to 7% of GDP throughout the period up to 2028,” Gaspar explains. Yet “growth has slowed and the medium-term prospects are the weakest in some time” for both of the globe’s two biggest economies.

A big worry in China’s case is the opacity built into the Communist Party’s growth model, including the explosion of off-balance-sheet borrowing via local government financing vehicles (LGFVs) since the late 2000s.

The priority now, Gaspar says, is to reduce China’s long-standing reliance on real estate and enormous infrastructure projects for growth. “The challenge for China is growth, stability and innovation,” Gaspar argues.

“China,” Gaspar says, “has ample policy space” and “multiple options” to pivot to a new growth model that prioritizes domestic demand over exports and investment. He says examples of those options include innovation in the electric vehicle and alternative energy spaces.

A key focus must be on prodding households to save less and consume more. “The problem for China today is its big savings imbalance,” says Eric Khaw, senior portfolio manager at Nikko Asset Management. “Today, China has one of the highest savings rates within the region, and the savings rate is much higher than the investment rate, which has been impacted by a secular fall in investment demand.”

What this means, Khaw says, “is that China, with its excess savings, will need to have higher leverage. If you look at the level of private debt across the board, you will see that it is lower than those of the US, South Korea, Japan and many other countries.”

Likewise, he adds, China’s public debt is only about 71%, according to IMF data. That’s “significantly lower than those of Japan and the US. So, there is quite a lot of headroom to increase the country’s leverage rate, in our view,” Khaw says.

The “bigger the savings,” Khaw says, “the more borrowing and lending will have to be done for China’s financial intermediation. Savings need to be transformed either into domestic investment or lent abroad. In the past, China could export its surplus savings abroad. But now, Chinese exports are limited by geopolitics. Spending may be the only way out for the Chinese government.”

So, arguments like Yu’s, that getting back to 6% requires a debt-fueled stimulus boom, only perpetuate the boom/bust cycle that Xi’s team hopes to break. Raising China’s economic game means risking new and disruptive policies, not leaning on the safe strategies of the past.