China is determined to restore its economy by using its budget "firepower" and still maintains a good position thanks to this.

China's Finance Minister Lan Fo'an said Beijing will step up fiscal spending to support the struggling recovery from the Covid-19 pandemic.

Specifically, the world's second-largest economy will deploy a stockpile of government and local government bonds, including a new treasury facility worth 1 trillion yuan ($140 billion) to maintain the intensity of fiscal spending at an appropriate level. This will push Beijing's budget deficit to a two-decade high of 3.8 percent this year.

While the message was welcomed by investors, many analysts question how much fiscal firepower Beijing really has to fuel stronger economic momentum?

Street in Beijing, China. (Photo: Linh Chi)

Huge bad debt

Investors say that currently, in China, economic growth is slowing, the investment-driven development model is losing momentum and tax revenue is under pressure. In this context, Beijing is reluctant to borrow more because the country is facing a huge amount of bad debt that needs to be resolved at the local government level.

“Fiscal policy has been a long-term issue in the country of a billion people,” said Logan Wright, director of China market research at Rhodium Group.

This year, as the economy struggles to recover from the Covid-19 pandemic and the ailing real estate market, the government has decided to gradually loosen fiscal policy.

Following the 2008 financial crisis, the world's second-largest economy launched a 4 trillion yuan stimulus package - equivalent to 13% of the country's gross domestic product (GDP).

This time, the Chinese government is not looking to leverage its recovery in this way. Mr. Logan Wright said that compared to local governments, which had debt worth about 76% of GDP, the central government had only about 21.3% last year.

“Beijing has significant financial resources at its disposal,” said Fred Neumann, chief economist for Asia at HSBC. “The country has the ability to add debt worth around 20-30% of GDP, which will help address the local debt problem.”

China's net financial position, which takes into account assets such as equity holdings, is among the world's top 15, at 7.25% of GDP, International Monetary Fund (IMF) analysts said in a paper released in August.

However, most analysts believe that the central government’s true debt obligations are much larger than those figures suggest. Beijing serves as the ultimate fulcrum for the country’s total government debt. Rhodium Group estimates that total government debt stood at 142% of GDP last year, including debt held by the central government, policy banks, local governments, and local government financing vehicles.

China's central government is prioritizing risk prevention. (Source: Reuters)

The most urgent problem

Solving local government debt has become one of the most pressing issues for Beijing.

The IMF has raised its forecast for China's economic growth this year to 5.4% from 5%. However, the fund said Beijing still needs to implement appropriate financial reforms.

Beijing has asked state-owned banks to cut interest rates and extend local government lending terms since September 2023. The world's second-largest economy has allowed provincial governments to issue bonds to repay debt financing vehicles.

By early November, at least 27 provinces and one municipality had issued 1.2 trillion yuan in bonds, using local bond sales quotas that had been allocated in previous years but not fully utilized.

China’s central government is prioritizing risk prevention, according to macro research firm Gavekal Dragonomics. The country prioritizes preventing damaging defaults in the bond market, which could have a huge ripple effect on financial markets.

There are signs that Beijing is becoming less demanding of local governments on growth targets, which could reduce the need for excessive borrowing in the future, said Chris Beddor, deputy director of China research at Gavekal Dragonomics.

However, analysts note that local governments in the country of one billion people are facing a situation where they cannot raise enough revenue to cover their spending. Under the 1994 reforms, the Chinese government will control tax revenue, while local governments will be responsible for providing more services. Lack of cash to meet all obligations has led many local governments to borrow excessively.

“There needs to be a change in the financial structure to help local authorities get out of that situation,” Mr. Chris Beddor emphasized.

In addition, as China shifts to a more consumption-driven model, revenue from property sales and value-added tax will decline. Total tax revenue as a percentage of GDP fell from 18.5% in 2014 to 13.8% last year, according to Rhodium analyst Logan Wright.

Experts say it will take several years for the world’s second-largest economy to stabilize and for the private sector to regain full confidence. But China’s economic fundamentals are strong, the government has considerable policy space, and industrial development will position the country well for the future.

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