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Thursday, March 04, 2021
Fiscal Sustainability: Key Challenge to China in 2021
ANBOUND

China's "Two Sessions", or Lianghui, the annual gatherings of the Chinese People's Political Consultative Conference (CPPCC) and the National People's Congress (NPC) have already started. The theme for the Two Sessions in 2021 is the formulation and implementation of the "14th Five-Year Plan" for China's long-term development. In the first year of the "14th Five-Year Plan", China's economic goals and implementation will be one of the main issues. Fiscal and monetary policies in the post-pandemic period will be clarified at the Two Sessions. As monetary policies return to neutrality, the emphasis will be on stability and not to make any drastic changes, while the recovery and promotion of the economy will be reflected in the fiscal policy. Issues such as the formulation of the fiscal budget, the fiscal deficit rate, and the scale of new government debt are all the focus of attention for the sessions this year.

Judging from the central work conference and the recent statements of financial officials, this year's fiscal policy will still maintain a moderately "positive" orientation so as to sustain the promotion and support of the macro economy. Recently, Minister of Finance Liu Kun reiterated at the video conference of G20 Finance Ministers and Central Bank Governors Meeting that they should coordinate in pandemic prevention and economic recovery to avoid premature withdrawal from economic support measures. In 2021, China will continue to implement a proactive fiscal policy and a prudent monetary policy, and maintain the necessary support for economic recovery. From this point of view, compared with last year's "proactivity", the intensity of fiscal policy this year will be moderately reduced.

A number of market institutions believe that this year's fiscal policy will be relatively prudent compared to that of last year. This year, China's fiscal deficit rate may be set at 3%-3.5%, down from 3.6% last year, and the new quota of local government special bonds may be reduced to RMB 3-3.5 trillion. This would be the first instance of a full implementation of local government bond issuance since 2015. Hua Changchun, global chief economist at Guotai Junan Securities, believes that although the fiscal policy will shrink marginally in 2021, the pace of fiscal policy withdrawal will be relatively slow, but there is a high probability that there will be a moderate exit. Hua Changchun predicts that the deficit rate will be set at around 3.2%, and the new special debt issuance will be RMB 3.5-3.6 trillion. At the same time, taking into account the pressure on fiscal revenue, there is little room for the macro tax burden to continue being substantially reduced.

As the economy gradually recovers and the endogenous driving forces for economic development continues to increase, the focus of fiscal policy in China this year should be to increase revenue in order to achieve more fiscal sustainability, thereby alleviating increasing fiscal pressures which can also serve to accumulate policy space for the future. It is even more vital to consolidate the foundation of fiscal revenue and stabilize financial and tax sources, especially for local governments. The rating agency Fitch also mentioned that due to the increase in public sector debt last year and the economy has clearly recovered, local governments will shift their focus to increasing fiscal revenue this year.

In response to the pandemic and the resulting economic downturn, proactive fiscal policies that focused on expenditures and consciously expanding government debt were implemented to cope with the increase in expenditure. In 2020, the national general public budget revenue was RMB 18,289.5 billion, a year-on-year decrease of 3.9%, and an increase of RMB 262.5 billion from the budgeted revenue. The national general public budget expenditure was RMB 24,558.5 trillion, a year-on-year increase of 2.8%, and a decrease of RMB 226.2 billion from the budgeted expenditure. The national fiscal revenue and expenditure gap was RMB 6269.3 billion, a decrease of RMB 488.7 billion from the budgeted revenue and expenditure gap. Although the overall fiscal performance last year was better than expected, the rigidity of fiscal expenditures and the decline in revenue have significantly increased the fiscal deficit and increased the government's debt burden.

With the increase in government spending, government debt is becoming increasingly unsustainable. According to data from the Ministry of Finance, as of the end of last year, the national government debt balance was RMB 46.55 trillion, with a debt ratio of nearly 46%, a rise of more than 7 percentage points from the previous year, the largest annual increase in history. The growth rate of government debt interest payments rose to 16.40%, an increase of 3.8 percentage points from 2019. Former Minister of Finance Lou Jiwei warned not long ago that Chinese financial difficulties are not short-term issues, but is rather a medium-term problem. Lou Jiwei believes that blindly relying on deficits and debts will not be sustainable. Researchers at ANBOUND have warned that the increasing financial pressures that China has been facing in recent years may be particularly severe this year. Moreover, these pressures may be transformed into risks for financial market, the economy, and the society, which will hinder the realization of economic development goals. Fitch also mentioned that the recovery of budget revenue of various local governments this year will be inconsistent among different regions as well as different levels of government. Local economic and fiscal conditions could further "differentiate", causing the risks in local finances of underdeveloped regions to increase.

From the perspective of "improving quality and efficiency", the efficiency of the proactive fiscal policy, which focuses on reducing taxes and fees and expanding infrastructure investment, is declining. Although these policies have played a significant role in cultivating market players, reducing corporate pressure and promoting investment demand, there is not much room for tax cuts and fee reductions in the future. In other words, this will stretch out local finances and reduce the efficiency of policies. The continuous increase in government infrastructure investment is also facing the problem of declining income, which has no obvious effect on promoting the increase in demand for fixed asset investment. At the same time, excessive use of financial resources has caused the government to occupy too much financial resources, which has brought about a long-term decline in market vitality, and essentially became a major obstacle in dual-circulation framework. Therefore, increasing revenue to maintain fiscal balance and sustainability is more effective than expanding expenditure.

From our perspective, we believe that a key challenge that the fiscal policy will face this year is the sustainability of central and local fiscal policies. The main focus of the fiscal policy is income. In the course of sustained economic recovery, by expanding upon financial resources as well as taxable sources, increasing nontaxable income through various means such as mutual funds, it is possible to tap into market investments and state-owned enterprise income. In terms of expenditures, it would be necessary to focus on people's livelihood, rural revitalization, technological innovation, as well as to achieve a precise and prudent monetary policy.

Final analysis conclusion:

This is the first year of China's "14th Five-Year Plan", and it is also a year that is deeply affected by the COVID-19 pandemic. Fiscal sustainability will be a key challenge that China's economy will be facing, as it is directly related to social governance and the stability of economic operations.

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