More on the Chinese fiscal stimulus

The Chinese fiscal stimulus has provoked much debate since being announced last Sunday as analysts try to assess its impact. Will it succeed in cushioning China’s economic performance, will it contribute to more domestic imbalances? a first area of debate fixates around how much of the investment to be approved is “new” that is not included in the current 5 year plan and budgeted as such. Around 1/3-1/2 of the projects seem to be new, previously unannounced spending while much of it is a compilation of initiatives already announced or items that were already scheduled in the current five year plan.

Details of new spending have focused on the infrastructure investment and include:

120b RMB ($18b) new spending in Q4

an extra 200b RMB for earthquake reconstruction in 2009 (up from previously planned 1T). The Total 1.2T RMB may be included in the 4T RMB headline figure.

extra 500b RMB on the railroads

VAT reform (previously rumored to be phased in by the new year which might encourage businesses to make more capital investment). This might reduce revenues by 100-120b RMB (perhaps this doesn’t exactly fit as fiscal stimulus, but rather is part of tax policy changes) Undisclosed amounts to support grain purchases to boost prices for rural farmers, undisclosed additional social spending (transfers to social security fund, health care transfers) The latter two groups of policies are longer term in focus than the infrastructure spending and are designed to support consumption, a key element of China’s sustainable growth trajectory in the future. Indicators of Chinese private consumption show a mixed story. Retail sales remain robust – they averaged 22% y/y growth in October, matching the June –October average. But such an outlook doesn’t seem sustainable with the  industrial production at a 7 year low, export orders being cancelled. With profits down and the negative wealth effect of the equity and property market, private consumption will likely suffer – meaning China still may still not account for much global final demand. As such the stimulus may have the most boost on producers of natural resources, rather than on producers of consumer goods.

Growth effect

The net result of the new stimulus will be a further ramp up of infrastructure investment perhaps rising as high as 38% of GDP from the 6-7% of recent years, contributing 2.5ppt to GDP growth in 2009 (Morgan Stanley). Other estimates suggest that the new spending will add somewhere between 1-1.5ppt to GDP helping to offset other weakness. This seems about right – as does the lower end of the now consensus 7-8% forecast growth rates for 2009. But despite the stimulus, 6% growth still does not see out of the question.

Note the following text has changed slightly since initial posting.

Furthermore, it will be important to watch if the implementation of the stimulus exacerbates ongoing dynamics. As Victor Shih points out, regions that are more developed may actually be better able to open the spigot as they are more likely to have projects ready to go. Whlle supporting coastal regions hit by factory closures is likely a focus of the stimulus, it may still obscure micro level disparities. Regional and local level investment already accounted for 75% of total infrastructure investment, meaning that they will be responsible for such projects once approved by the federal government And local level authorities are more cash strapped than those at the federal level in part because they are hard hit by local property market weakness (so they will turn to the banks) The government is optimistic. It suggests that the new federal spending of 120b RMB plus local government and private sector spending could take the aggregate total to 400b RMB in Q4– or over 5% of Q407 GDP.

Key regions will clearly be prioritized – media reports suggest that governments in 12 key regions are estimated to approve spending of over 1.5T RMB in the coming 100 days as race to spend accelerates. Many of these projects may have been slated for coming years or may have been mothballed as part of past efforts to avoid overheating, conveniently now providing a pipeline.

Furthermore, should the plans not have the desired effect and macro outlook worsen, China may further scale up fiscal and monetary responses. Doing so might require significant borrowing – fiscal revenues actually slipped in October. Financing

This increased spending does come at a time when spending growth was already outstripping revenue growth as lower corporate profits, lower volume on property and equity market trades eroded revenues. However, China may be able to avoid a large fiscal deficit – estimates suggest anywhere from 1-2% of GDP next year.

Funding will be split between new debt issuance, which has been lower this year to date and bank lending.

Banks will likely be persuaded to go along, and having held back from investing in property because of the credit risk, they may have more funds to lend. The government seal of approval will likely greenlight funding. .The government already removed credit controls and has been urging banks to lend. However, banks and others will have to be careful not to create a new vulnerability while responding to an old one – There is a danger of a return of policy based lending and NPLs. And to support private consumption, getting capital to the SMEs will be very important.

Global implications

There has been no shortage of discussion on the role China, the US largest creditor and holder of the largest foreign exchange reserves might play. It is striking that Asia, the largest global surplus region has been relatively absent in global discussions so far, this might change this weekend and in months to come. But for now key asian economies may be more focused on domestic not global concerns despite the looming vulnerabilities stemming from further slowdown in the US, Europe and commodity exporting economies. But at least some of what is good for China, might be good for the world.

The timing of the Chinese package is likely influenced both by domestic demands, and the external outlook. The timing before the G20 heads of state is clearly significant. Though its interesting to note that the Chinese finance minister flew home from APEC and did not attend the G20 finance ministers meeting in order to take part in finalizing this package. Yet especially for exports, worse news seems likely ahead. Chinese infrastructure demands might therefore put a floor in falling commodity prices, particularly as the credit crunch and falling demand may depress investment.

Chinese officials have suggested that the best way China can support global demand is to help itself, to support its own economy and (hopefully) to do so in ways that support its long-term development and sustainable growth pattern. It is striking that the current stimulus includes both tried and tested measures of scaling up infrastructure but also social spending that may contribute to rebalancing China’s domestic economy in years to come. Or so one hopes, the balance of these two is still skewed towards infrastructure spending. Either way, it looks like a tough year ahead. But hopefully one in which we can revisit institutional structures, finally insert emerging economies into global regulatory bodies to better respond to the next crises.

11 Responses to "More on the Chinese fiscal stimulus"

  1. Victor   November 13, 2008 at 2:22 pm

    “However the real effect of the announced stimulus from the federal government may stem from its ability in mobilizing other capital – ie how successful the increased federal commitment and moral suasion will be in convincing banks to lend to local governments. Regional and local level investment already accounted for 75% of total infrastructure investment, meaning that maintaining and increasing such programs will be important for the stimulus to have its desired effect.”This is somewhat misleading. The 4 trillion RMB figure only means that the government (ie NDRC) is ready to approve 4 trillion worth of investment. The financing will be central bond issuance, bank loans, and local budgetary expenditure. In order to secure the first two pieces, local governments must front the third piece in most cases. In the past, that has had a regressive effect in that rich regions are more able to provide financing. ALL the projects will be implemented locally by local governments, thus long lines outside of the NDRC office now.

  2. Rachel   November 13, 2008 at 5:20 pm

    Many thanks Victor – you’re correct this was misleading. it does of course mean that those regions which already had plans together that were frozen in the past are probably ready to go and may receive a greater share of the approvals. Thanks as always for your insight and analysis

  3. Peter   November 14, 2008 at 7:47 am

    I believe that the Chinese leadership is no longer interested in financing the US bailout of its own economy (In so far as it would be, surely it would have been a better use of Chinese taxpayers’ money to invest directly into the stock market rather than to invest into low yielding bonds in a devaluing USD). The catch is it can only stop buying unless it can see that its measures to promote consumer spending is actually working. What’s your view on whether China can promote consumer spending and what would be your policy recommendations to do so?It is also interesting that China believes that its best bet is to take advantage of a global deflationary cycle to spend big on its economy – thereby allowing strong growth without fear of domestic inflation. This policy could see the US moving into mild stagflation.It’s interesting strategically that better than expected consumer spending in China would be a signal to sell US assets (treasuries and stocks) as it means that China has successfully diverted economic growth away from the US and into China.How’s this for a hypothesis?

    • Morbid   November 14, 2008 at 9:06 am

      The Way Back Is The Way ForwardI know this may “sound” awful but the West has corrupted China with its materalistic driven worldview. It is a pyramid scheme at best. It only works if ever more players are added. How many billions can the planet support? What is the logical conclusion of where this economic model leads us all? An ever higher cliff as near as I can make out – over which the rushing herd will go. The first in win – the rest will lose.The idea that one size fits all is a great mistake for nature Herself prefers to conduct as many experiments as possible. So I am in favor of local economies, home grown. This One World Order financial Tower of Babel has put untold millions of humans in harms way. All that for a few bucks? It is a USA national disgrace that we have exported this nonsense.

      • Anonymous   November 15, 2008 at 3:19 am

        Morbid, thanks for painting the (us) Chinese as free of Original Sin! However we really don’t need such silly and uncouth stereotypes here (same stereotypes of Tibetans that get Westerners googoogaagaa about the evils of either capitalist or communist materialism). Although US primary school history books won’t tell you this, Globalization is not an American invention. It started as early as the 7th century and included the entire old world ex. Europe.

    • artichoke   November 15, 2008 at 2:05 pm

      The hypothesis sounds right to me. China is trying to knit alliances around the US, to decouple. They cannot be any more sure than we are about how successful they will be, but like all their economic operations of the past 15 or so years, it is being done with extreme competence.

    • Rachel   November 18, 2008 at 1:39 pm

      the best way to promote consumer spending is to lessen some of the extreme incentives to save. ie the Chinese government could spend more on health, education and other social services to lessen the amount individuals have to self-ensure. As a country, China might need to take on some debt.China is spending more on its economy. what is striking though is that it is still spending a lotConsumer spending has remained quite strong in China – even stripping out inflation, remaining well above 17% – however, this alone is not sufficient to suggest that China has diverted growth away from investment towards consumptionAnd despite the fact that exports are slowing, there really hasn’t been a slump (yet). exports grew 19.5% in October. But perhaps the real appreciation of the RMB and slower demand from commodity exporters might lead to further slowing ahead.

  4. Guest   November 16, 2008 at 4:45 am

    China has more in common with western crisis economies than is generally supposed. The recent furor over favoritism and waste in the American bailouts has its counterparts in East Asia. China will almost inevitably experience a growth and currency collapse similar to the “5 Tigers” debacle of the mid 90’s:China: A Systemic Earthquake is ComingThere is something rotten about the Chinese economic miracle.Unseen to most observers and obscured beneath the heavy mantle of secrecy that shrouds all policy decisions here, a clique of capitalists within the Communist party hasbeen gaming the system. Billions of dollars in public money have been siphonedinto private ventures and money making schemes. At the summit of this corruptpyramid are the nation’s banks.Bank of China, Bank of Communications, China Construction Bank and Agricultural Bank are, in theory, owned by the state. But their balance sheets are even more questionable than those of the American banks which hold trillions in off-balance-sheettransactions. Nobody but top bank management and a handful of officials in the Finance Ministry really know where the money is.In fact, to fuel the nation’s stunning economic growth planners at the Economic and Reform Commission have tacitly allowed the diversion of public money for privatePurposes. The result is a chronic national budget deficit which has been financed byMoney printed at the People’s Bank of China.The shakiness of the seemingly rock-solid façade of the nation’s premier financial establishments is about to be shaken again. They’ve already lost billions in the agonizing,70% decline in the Shanghai stock market. Now by government fiat they’re going to beforced to lend to favored enterprises at negative real interest rates. The predictable result will be another surge of inflation and a Yuan crisis in two to three years.A foretaste of the carnage was provided by the recent announcement of a $14 billion bailout of Agricultural Bank. Small by western standards, the bank rescue was stillSurprising after years of stunning growth and reported earnings surpluses.But the worst is yet to come. And when the full extent of the capitalistic infection of thisNominally socialist system becomes clear, the political repercussions will be profound.It is quite possible that the current leadership team of Hu Jintao and Wen Jiabao will be forced to resign before their terms of office formally expire in five years. Also likely is a complete shakeup of the list of their prospective successors when the Communist Party Congress again in a few years.

  5. Li Yamei   November 18, 2008 at 2:56 am

    Sitting in Shanghai, it seems like the effects of the US crisis have largely not yet reached China’s shores. Yes, thousands of export-oriented manufacturing enterpises in Southern China have closed this year and many workers have been laid off, but these events started taking place last winter when rising energy costs and labor rates started to take a toll on the low-value manufacturers based in Dongguan and Shenzhen. More recently, laid-off factory workers are reported to be giving up their quest for work in the eastern coastal regions and are heading home to their villages, but again, this isn’t really impacting domestic demand as they tended to be low-paid wage earners who saved most of their earnings to send home to their families in the countryside. I expect that the real scale of the crisis will become more apparent in China after US retailers have a dismal holiday season and sharply curtail Q1 factory orders. Then, it may become rather grim and the question is whether enough of the stimulus package will have been activated to offset the worst of the effects. Given how much reliance on infrastructure projects there is in the package, it seems like in the short term, it may not avoid as much hardship as the government would probably like.

    • Rachel   November 18, 2008 at 1:32 pm

      Thanks for your comment – there is definitely a regional divergence in Chinese growth. Arguably already US retailers (and European ones are cutting back) meaning that the early rounds of closures that we have seen so far may not be the last ones.And the question is does this all mean that there will be another stimulus package, especially if construction continues to weaken

      • Li Yamei   November 19, 2008 at 2:37 am

        In a discussion today among various professionals based in Shanghai working in the areas of real estate and financial services, the majority thought economic growth in 2009 would be in the 7% – 8% range (2 or 3 thought it would be 6% or lower). However, there seemed to be a sense that in the next 6 months, the loss of factory jobs would NOT be offset by the stimulus package. If there is a lag between the implementation of the stimulus package and its effects, I think we should expect either a further and significant loosening of credit, or an additional stimulus (maybe on a province-specific basis), or both. Reputedly, the State Council called the provincial leaders to BJ right before the package was announced for them to report to the national leaders on how the crisis is expected to be experienced in each locality and for the national leadership to convey to the provincial leaders that priority one is making sure the stimulus package is used promptly and properly to offset these risks. Wish there were that much coordination in the US!