Opinion

Reading tea leaves from China’s two sessions: Large monetary and fiscal stimulus and still no growth guarantee

The announcement of a large stimulus without a growth target indicates that China’s recovery is far from complete.

By: Date: May 25, 2020 Topic: Global Economics & Governance

It was hard to think of a more important gathering than last week’s ‘Two Sessions’, during which Chinese political leaders were to guide all of us as to the way ahead for the Chinese economy. While this yearly event is always important, this year’s was crucial. 2020 marks the end of two key cycles of economic planning: the current Five-Year Plan, and the end of the 10-year period during which the country aimed at doubling its income, which is the operational target to measure President’s Xi Great Rejuvenation plan. Expectations were running all the higher that the Chinese economy is reeling from unprecedented levels of uncertainties due to coronavirus epidemic – including delaying the event itself – compounded by the fact that China had shown a rather hesitant approach to stimulus since January.

The new guidance that emerged from the ‘Two Sessions’ marks a major departure from traditional economic management in China, as China’s leadership opted not to set a growth target. This also suggests rather low expectations for economic activity this year and probably the next, as hinted by the rather high unemployment target (6% last April).

Meanwhile, references to lower interest rates and a higher inflation target point to a much laxer monetary policy in the months ahead. In parallel, a large fiscal stimulus is to be expected, as authorities announced a nearly 40% increase in additional financing for local governments, from RMB 2.6 trillion last year (€334 billion) to RMB 3.75 trillion (€481 billion) in 2020, as well as an additional RMB 1 trillion (€128 billion) in special treasury bonds. The Chinese government had not resorted to this type of off-balance sheet bonds since 2007. The magic of it all is that the target for the fiscal deficit remains low for the sharp increase in bond issuance, namely at 3.6% of GDP in 2020.

The announcement of a large stimulus without an attached growth target worryingly suggests that China’s recovery is far from complete, two months after the COVID-19 epidemic was brought under control in the country. This is especially true for the demand side. External demand remains extremely weak as virtually the whole world has also been hit by the pandemic. Even more worryingly, the meagre retail sales and looming deflationary pleasures clearly indicate that domestic demand also remains feeble.

The need for more stimulus is thus a no-brainer and Premier Li’s announcement should be welcomed. If the stimulus is reoriented toward targeted and more productive investment, growth should be able to resume more easily but perhaps with lingering unemployment. The creation of a stronger welfare state seems warranted to maintain income levels high enough to protect households and safeguard domestic consumption.

Higher debt

However, there no such thing as a free lunch. The mirror of additional stimulus is more leverage. Without a privatisation programme, all signs point to higher public debt because of the stimulus announced. The pre-announced land reform should help generate wealth for the rural population but it is hard to see how that would reduce public debt. If anything, it might even raise it, as there might be a transfer of wealth from local governments, who have less land sale revenue, to the rural population.

We estimate that China’s consolidated fiscal deficit has hovered at around 8% in the past few years, which implies that public debt was piling up even before COVID-19 hit the Chinese economy. While most of the increase is associated with local government financing vehicles, it seems clear that China’s fiscal space is not as large as it used to be. Considering that a significant part of China’s corporate debt is in the hands of state-owned companies (about 60% of listed companies), Chinese public debt on a consolidated basis would be higher than that of US or most European countries. The good news, though, is that China has enough domestic savings to hold this debt domestically and it will be able to reduce the size of the debt once the negative economic consequences of the pandemic are fully under control. In this regard, one should expect financial repression, supported by capital controls, to become even more pervasive, to cushion the negative impact of further accumulation of public debt.

Premier Li has so far not offered guidance on how this money will be spent. Several actors are pushing to use this opportunity to further enhance China’s digital infrastructure. While clearly welcome, this strategy might not spur the necessary job creation needed to sustain employment and disposable income. Chinese leaders might therefore be tempted to give up on such high hopes and use the stimulus for more labour-intensive sectors such as infrastructure and real estate. However, pervasive over-investment in those sectors among others means it is difficult to find profitable projects to invest in.

Supporting domestic demand

Other measures will be needed to keep workers’ disposable incomes stable for a more targeted and productive stimulus. The most obvious solution is to ramp up China’s welfare state, not only out of fairness or pure populism, but above all to ensure economic efficiency. Better allocation of resources can cushion China’s unavoidable structural deceleration and the productivity gains need to be used to support household income through fiscal transfers so that China’s long-standing pursuit of a consumption-led growth model can be achieved. There is no better way for a society to rejuvenate than to be able to provide a sufficient safety net for the losers from economic transformation, while moving up the ladder through innovation. With such a policy mix, the pandemic might indeed pass into China’s history as the opportunity that the leadership grasped for the Chinese economy to modernize itself.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to [email protected].

Read article More on this topic
 

Blog Post

Europe’s China problem: investment screening and state aid

China’s state capitalist economy poses a challenge to EU openness to foreign investment. In response, the European Commission 17 June published a White Paper on “levelling the playing field with regard to state aid”, contemplating sensible and balanced policies to protect the integrity of the European single market from subsidised foreign acquisitions. However, against the backdrop of collapsing global capital flows and limited existing FDI from China, there is little risk of excessive exposure, indeed a deepening of bilateral investment flows would be beneficial for both economies.

By: Marta Domínguez-Jiménez and Niclas Poitiers Topic: Global Economics & Governance Date: July 2, 2020
Read article Download PDF More on this topic
 

Policy Contribution

The financial fragility of European households in the time of COVID-19

The concept of household financial fragility emerged in the United States after the 2007-2008 financial crisis. It grew out of the need to understand whether households’ lack of capacity to face shocks could itself become a source of financial instability.

By: Maria Demertzis, Marta Domínguez-Jiménez and Annamaria Lusardi Topic: European Macroeconomics & Governance Date: July 2, 2020
Read about event More on this topic
 

Upcoming Event

Jul
7
14:00

An EU budget for Europe's future with Johannes Hahn

How do we make the EU fit for future?

Speakers: Zsolt Darvas, Johannes Hahn and Mehreen Khan Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic
 

Past Event

Past Event

Impact and additionality assessment in the time of COVID-19

Understanding the impact and additionality of policy interventions.

Speakers: Ugo Albertazzi, Benoit Campagne, Andrea Conte, Zsolt Darvas, Maria Demertzis, Francesco Di Comite, John Earle, Matteo Falagiarda, Áron Gereben, Helmut Kraemer-Eis, Hans Peter Lankes, Iana Liadze, Andrew McDowell, Nicola Pochettino, Debora Revoltella, Mattia Romani, Simone Signore, Natacha Valla, Georg Weiers and Marcin Wolski Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: June 30, 2020
Read about event More on this topic
 

Past Event

Past Event

The need for market-based finance after COVID-19

How do COVID-19-caused financial dislocations inform policy responses?

Speakers: Maria Demertzis, Gabriel Makhlouf and Guntram B. Wolff Topic: Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: June 29, 2020
Read article More on this topic
 

Blog Post

Artificial intelligence’s great impact on low and middle-skilled jobs

Artificial intelligence and machine learning will significantly transform low-skilled jobs that have not yet been negatively affected by past technological change.

By: Sybrand Brekelmans and Georgios Petropoulos Topic: Innovation & Competition Policy Date: June 29, 2020
Read article More on this topic More by this author
 

Podcast

Podcast

Redefining Europe’s role after the Covid-19 Pandemic

How will the Covid 19 crisis change the role of the EU in Europe and the world?

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: June 25, 2020
Read about event More on this topic
 

Past Event

Past Event

Redefining Europe's role after the COVID-19 pandemic

Amidst COVID-19: how to keep markets integrated when states play a bigger role in the EU and its neighbourhood?

Speakers: Gabriele Bischoff, John Erik Fossum, Kalypso Nicolaïdis and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: June 25, 2020
Read about event More on this topic
 

Past Event

Past Event

COVID-19 in CEE and Europe’s neighbourhood: Do we need a Vienna Initiative 3.0?

How is the Vienna Initiative evolving to respond to the crisis caused by COVID-19?

Speakers: Thomas Wieser, Pierre Heilbronn, Mark Le Gros Allen, Piroska Nagy Mohacsi and Boris Vujčić Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: June 24, 2020
Read article More on this topic More by this author
 

Opinion

A tale of two pandemics

The two narratives briefly examined here cast light on different aspects of the EU in the times of Covid-19. Euroskeptic nationalists typically propagate claims of EU failure but have been rather subdued during the pandemic as mainstream governments have taken over their trademark policy of closing borders to foreigners. Nonetheless, the grip on power of several pro-EU mainstream leaders, including President Emmanuel Macron in France, Prime Minister Conte in Italy and Prime Minister Pedro Sanchez in Spain, remains tenuous.

By: Michael Leigh Topic: European Macroeconomics & Governance Date: June 23, 2020
Read about event More on this topic
 

Past Event

Past Event

The role of AI in healthcare

How can AI help us fight through a pandemic crisis?

Speakers: Dimitris Bertsimas, Georgios Petropoulos, Effy Vayena and Reinhilde Veugelers Topic: Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: June 23, 2020
Read article More on this topic
 

Opinion

Toward a smart Indian response to China

Rather than risking its soldiers' lives on the border, India should join 'middle power' economic coalitions to address China's behavior.

By: Suman Bery and Alicia García-Herrero Topic: Global Economics & Governance Date: June 23, 2020
Load more posts