When will China pull the trigger on more economic stimulus?

A view from prominent economist Prof. Yu Yongding

May 29, 2023

Since April, earlier market enthusiasm for China’s economic recovery has been replaced by pessimism. Weak economic data, unemployment, local debt troubles, as well as the resurgence of new covid infections add to worries that China’s growth engine is sputtering. Even earlier stock markets star sectors such as AIGC and 中特估 VSCC have softened. Although we have explained that the actual situation was more nuanced (see previous posts on youth unemployment, industry and real estate activities, tourism, and luxury), it’s obvious that in order to make the market optimistic again, some very substantial economic stimulus is needed.

Within such a context, it is not surprising that recently voices for expansionary policies have continued to surface. For example, last Friday, a rumor begins to circulate that China is about to issue a massive 5 trillion yuan (~$700b) special government bond. So far, there has been no official denial or confirmation of such a rumor.

Today we are translating a concise but powerful article from Prof. Yu Yongding, a prominent China economist. The article was based on a recent speech given by Prof. Yu during a luncheon at IMF headquarters in Washington D.C. as part of the CF40 delegation.

The core message of this speech is simple: In order to boost income and increase overall demand, It is time to embark on a more determined expansionary economic policy in the form of more public expenditures by issuing more government bonds, while the risk of corporate leverage is manageable.

Expansionary macroeconomic policies are still needed to boost the economy

By Yu Yongding

Insufficient overall demand is currently the most prominent problem facing China's macroeconomic operation. Due to the lackluster economic growth performance in the first quarter of 2023, especially with the low CPI growth rate and continued negative PPI growth, China needs to adopt stronger expansionary fiscal and monetary policies. The Chinese fiscal authorities need to increase the deficit ratio and issue more national bonds, while the monetary authorities should further lower the benchmark interest rate.

While stimulating consumption can help increase effective demand, consumption is a function of income. In the current situation in China, consumer demand is difficult to become the first driving force for sustained economic growth. Therefore, the main driving force for economic development needs to be infrastructure investment led or supported by the government (including "new and old" and "soft and hard" infrastructure construction). Infrastructure investment can not only directly create effective demand but also promote private investment through the "crowding-in effect." The growth of GDP and household income can drive consumption growth, thus forming a virtuous circle of economic development.

By boosting market confidence and implementing expansionary macroeconomic policies, the Chinese economy can definitely submit a satisfactory answer to the world in 2023.

As for the issue of debt and high leverage, compared with other major countries in the world, the Chinese corporate sector relies more on debt financing, especially bank loans. Excessive leverage can easily lead to debt defaults due to external shocks or internal management issues, but the high leverage of Chinese enterprises has its own unique characteristics.

For example, the degree of reliance on external funding by Chinese and American enterprises is similar. The significant reason for the high leverage of Chinese enterprises compared to American enterprises is that American enterprises mainly rely on stock market financing while Chinese enterprises mainly rely on bank loan financing. However, the current Chinese banking system is relatively sound, with a non-performing loan ratio of no more than 2%, and various indicators such as loss provisions are relatively healthy. In addition, the proportion of Chinese government debt to GDP is not high, and even including local government debt, China's government finances are still far better than most developed countries.

Therefore, China does not need to overly worry about high corporate leverage and be afraid to adopt expansionary fiscal and monetary policies.

The key to sustainable government finances depends on the GDP growth rate and interest rate levels, rather than the proportion of current government debt to GDP. If a high GDP growth rate and low interest rate level can be maintained, there will be no fiscal crisis due to debt issues.

On this basis, we need to pay attention to the following three points:

First, we must recognize that China's current problem is insufficient total demand. The central government's view that inadequate total demand is the prominent contradiction facing the current economic operation is very correct and important. The formulation of China's macroeconomic policies, including fiscal and monetary policies, should be based on this judgment.

Second, investment in infrastructure, technology innovation and industrial chain restructuring should become an important way to stimulate China's GDP growth in 2023. To stimulate the economy, we hope to increase consumer spending. By equalizing income distribution, adopting a series of measures to facilitate consumption, adjusting the tax system and increasing residents' disposable income, consumption can be increased. However, as the central government has pointed out, "consumption is a function of income." Without income growth, it is difficult to increase consumption. If we can start the economy through large-scale investment, the growth rate of consumption will increase, and the Chinese economy will form a virtuous cycle.

Third, to achieve the above goals in the future, I believe that we should further increase fiscal expenditure and issue more national debt. China should not be afraid to issue more national debt. China's national debt-to-GDP ratio is relatively low, and the size of China's national debt market is not large enough or deep enough. Expanding the national debt market is very beneficial for developing China's capital market. Therefore, we should increase fiscal expenditure and issue more national debt.

The central bank should further relax monetary policy. The central bank attaches more importance to reducing the reserve requirement ratio, which is necessary. However, I believe that it is more important to lower the benchmark interest rate. As for the issuance of loans, deposit and loan interest rates should be decided by commercial banks based on commercial principles.

Increasing fiscal expenditure, issuing more national debt, and lowering interest rates should be the basic characteristics of China's macroeconomic policies this year. Through a series of reform measures to boost market confidence and implement expansionary macroeconomic policies, I believe that the Chinese economy will be able to hand in a satisfactory answer to the world in 2023.

Our take

Public expression of opinions by key policy advisors supporting expansionary policies is a positive sign for market sentiment. Although the rumored “5 trillion” government bond plan may not be real, it is likely that similar policies are in the consultation stage. It is crucial to keep track of any further discussions along this line.

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