May 20, 2020

CHINA: National People’s Congress will signal tolerance for slower growth

BY Gabriel Wildau

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( 5 mins)
  • GDP and fiscal deficit targets announced at China’s annual parliament session will signal whether policymakers are prepared to accept slow growth.
  • Covid-19 presents an opportunity for to complete the transition away from reliance on annual GDP targets – a trend that was already underway before the pandemic.
  • The parliament will likely approve the issuance of rarely-used central government “special bonds” to re-capitalize small banks suffering from pandemic-related corporate defaults.

China’s annual parliament session, the National People’s Congress (NPC), will convene on 22 May after being delayed since early March due to Covid-19. As usual, the most important policy signals will be the GDP and fiscal deficit targets that Premier Li Keqiang will announce in his work report on the opening day. These targets will hint at whether Beijing intends to escalate monetary and fiscal stimulus, which has so far been modest compared both to other large economies and to Chinese responses to previous economic downturns.

GDP target: end of an era?

At the Central Economic Work Conference in December, top leaders reportedly agreed on a growth target of “around 6%” for this year, following growth of 6.1% in 2019. But after GDP contracted by 6.8% year-on-year in the first quarter, that target – which was never officially announced – is clearly unreachable.

Before the pandemic, China had already been moving to de-emphasize GDP targets, which have often been set above the economy’s sustainable growth rate, thereby forcing policymakers to resort to excessive debt-fueled stimulus and low-quality investments to achieve the targets. But expectations were that China was committed to at least one more annual target in 2020, given that growth of around 5.6% was needed to complete a long-term target – set in 2012 – of doubling 2010 GDP by 2020. Many observers believed that once this goal was achieved, China would abandon annual growth targets altogether. But with the doubling target already out of reach this year, the pandemic presents an opportunity to accelerate the move away from GDP targets.

An alternate possibility is that the NPC will endorse a more modest, less rigid GDP target of “around 2-3%.” A lower target would still relieve some pressure to escalate stimulus and could also enable the adoption of new policy tools – such as cash grants to households and businesses – that do not directly boost GDP but could be better suited to addressing the impact of the pandemic.

Fiscal policy: new tools available

China is likely to raise its official, on-budget fiscal deficit target to 3.5% of GDP from 2.5% last year. As always, however, the augmented fiscal deficit – which includes off-budget spending through local government financing vehicles (LGFVs) – is a more important gauge of fiscal policy. In a maximal stimulus scenario, the augmented deficit could exceed 13% of GDP compared to 7% in 2019, but the scale of LGFV spending will not be announced at the NPC. Instead, LGFVs will serve as a source of flexibility, enabling policymakers to calibrate stimulus as the year proceeds.

Though LGFVs will remain a wild card, the NPC will offer other clues about the size of this year’s augmented deficit – notably the quotas for so-called “special bonds” issued by both the central and local governments. The finance ministry does not count special bonds in the official fiscal deficit because these bonds are ostensibly re-paid out of cash flows from specific infrastructure projects or other assets, rather than from general revenue. Local government special bonds (LGSBs) are mainly used for infrastructure. The finance ministry has already approved RMB 1.8tn in LGSB quotas for 2020 and could approve an additional RMB 2tn at the NPC.

Greater uncertainty surrounds central governments special bonds (CGSBs). While LGSBs have become an established tool in recent years, CGSBs have been issued only three times since 2000, most famously to finance the re-capitalization of the Big 4 state-owned commercial banks in 2000. This time around, CGSB funding will likely be used to inject capital into small- and mid-sized banks, enabling them to increase lending to cash-strapped small businesses. Even before the pandemic, these banks were the main source of risk in China’s financial system, and corporate defaults triggered by the pandemic is causing further stress on these lenders.

Some portion of CGSB proceeds may also be earmarked for new stimulus tools. Unlike other major economies, China has so far not used direct cash subsidies to support households or corporate payrolls as part of its stimulus efforts. But some government advisors have recently called for such tools, which are newly attractive for several reasons: concern about excessive reliance on traditional stimulus tools like infrastructure and housing; severe unemployment pressure; and the Chinese economy’s increasing reliance on household consumption to drive growth. Li may propose the use of new income support policies at the NPC.

In recent weeks, a fierce debate has raged among Chinese economists and policy advisors about whether the People’s Bank of China (PBoC) should monetize CGSBs, i.e., purchase these bonds directly from the finance ministry. Pushback against the monetization proposal has been strong, however, suggesting that the size of the CGSB target will not exceed about RMB 1tn (USD 140bn), or 1% of GDP.

Though this pushback sends a signal that the size of the CGSB quota will be lower than the most ambitious proposals, in other respects the debate over debt monetization is largely academic. The PBoC is legally forbidden from purchasing government debt in the primary market, and that prohibition will not change. In reality, however, the PBoC regularly adjusts the size of its base money injections – mainly through cuts to the required reserve ratio and injections via open market operations – to ensure that liquidity in the bond market is sufficient to accommodate upcoming government bond sales. This practice of soft monetization will continue, as China continues its long transition from quantity-based to price-based monetary policy.

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