6 trillion or 12 trillion?

Evaluating the NPCSC meeting and the future

Last week was an unusual week. It was the week of the historic US election, which brought deep implications for China. At the same time, there was a National People’s Congress Standing Committee (NPCSC) meeting that was perhaps the most watched NPCSC gathering in living memory.

After all, it’s our legislature. In China’s political system, nothing that’s been brought to the attention of our legislature has not already gone through numerous rounds of consultation and consensus-building. In this case, it’s one particular role of NPC that the market is watching: formally approving amendments to our government’s budget.

After the unprecedented Sep 24 presser by China’s financial regulators and the Sep 26 Poliburo meeting that signaled a major pivot in China’s economic policy, the market had been eagerly waiting for a strong fiscal stimulus that went beyond mere monetary policies. The hopes ran high for the Oct 8 NDRC presser, only to be dashed later. The Oct 12 MoF presser somewhat salvaged the narrative, turning everyone’s attention to this NPCSC meeting, to be held in late October by tradition but for some reason was delayed to as late as last week.

Many people speculated the delay was due to apprehension regarding the US election, but I think the jury is still out on whether this is just pure coincidence.

In this post, we will evaluate the results of this NPCSC meeting, and gauge market reactions to it and its future implications.

Exactly how many trillions?

It is obligatory to start with a discussion of exactly how many trillions were approved by this meeting. Although the authorities tried hard to downplay the importance of an “X” trillion headline number, it’s really what most of the market cares about. And immediately, a debate was swirling about exactly how many trillions were there. This is a brief summary:

1. The most exact number is “6 trillion”, spread out through 3 years, which is the purely new extra debt limit quota that local governments are now allowed to carry in order to replace the “hidden debts”. This is essentially a debt-swap program to replace high-interest and short-maturity debt with low-interest and high-maturity debt, which will help relieve local government’s principal and interest repayment pressures. Another difference is that the “hidden debts” had uncertain credit status, while now they are formal government debts.

2. There is another “4 trillion”, although this is not a new debt allowance, but a re-designation or specification of existing debt quota to be specifically earmarked for replacing the hidden debts. It will also have a similar effect as the above.

3. There was another 2 trillion hidden debt related to shantytown development that would not be repaid until 2029.

The official stance was that in total 14.3 trillion yuan of hidden debts were recognized by the central government, and through the above measures, at least 12 trillion of it would not face repayment pressure by the end of 2028.

All of these measures were announced during a press conference on Friday, also chaired by Finance Minister Lan Fo’an. The timing of the presser was at 4 pm sharp after both mainland and Hong Kong markets had closed. This was a remarkable difference from the Oct 8 NDRC presser which was held during market hours, showing Chinese regulators have already drawn valuable lessons for their expectation management skills.

Minister of Finance Lan Fo’an: are you happy now?

Why is the market still underwhelmed?

This “debt-swap” program has not been enthusiastically received by the market. There are several reasons here:

1. None of the programs flows directly to residents, so its impact on consumption is more indirect. Theoretically, if the local governments have less pressure to pay interest and to repay debts, they will have more funds to settle unpaid bills and purchase more products and services from the private sector. However, the positive effect on demand will be less direct than a direct-to-resident cash handout.

2. A statement in the Ministry of Finance's report deserves attention, namely that this program will “not change local governments' debt repayment responsibilities.” This explains the real principle behind why this round of hidden debt is being swapped with local special bonds rather than special sovereign bonds. In other words, during the process of resolving hidden debt, policymakers are still adhering to the principle of ‘谁的孩子谁家报whoever's child it is should carry it', indicating that policymakers' stance hasn't changed significantly. This is considered a blow to market expectations.

3. Some people are worried that the central government has underestimated the scale of the hidden debt. While most of the estimates put total hidden debt levels at between 50 to 60 trillion, the center is only recognizing 14.3 trillion. (However, I do not think this is a problem. There will be more on this later)

4. There was also still lingering unrealistic expectation that the NPCSC would announce a big-bang bazooka to the tune of 10 or even 12 trillion, encompassing everything from debt swap, real estate buyback and direct-to-consumer cash handout, which was obviously not the case.

Resetting central-local relationship

I think the market expectation for a one-shot stimulus program is missing the point.

When you look at the Chinese economy today, the weakest sector in the entire economy is our local government sector. And since local government accounts for more than 80% of our government expenditures, effectively the entire government sector, a core engine of China’s economy, is in trouble.

Anyone who is counting on a Keynesian demand-side stimulus assumes that the government sector is ready to come in and fire its cannons. But in China’s case, the government sector itself needs to be fixed first. This is also because unlike US, which can print dollars almost indefinitely and let the world foot the bill, China can’t.

Therefore, any meaningful stimulus would not succeed without sorting through the mess at local governments first. A one-trillion or two-trillion cash subsidy program sent directly to residents that many foreign investors were dreaming about won’t solve this more urgent local government debt crisis. And even if there will be a direct-to-consumer support program in the future, it will be done mostly via local governments, not directly from Beijing like what the US did during the Covid years. This is because our vast regional disparity forbids the existence of a one-size-fits-all program that could only breed resentment rather than boost demand. In China, there is an old saying: “不患寡而患不均 We are more afraid of inequality than we are afraid of poverty”.

Fixing the local debt problem involves working on two somewhat conflicting tasks at the same time: 1) relieving some pressure off the back of local governments, while 2), installing fiscal discipline to avoid moral hazard so we do not end up in the same overinvestment-induced debt crisis again.

[The following content will be reserved for paying subscribers, who also have access to our lively member-exclusive Discord community]