MMT Makes Inroads in China With Calls for Bigger Fiscal Stimulus
China’s government is facing more calls to reduce its concerns about debt, with several influential economists arguing that authorities should follow the U.S. playbook and borrow more to spur the economy.
Unlike in the U.S., where President Joe Biden is ramping up stimulus to avoid the mistakes of a too-slow recovery in the aftermath of the global financial crisis, Beijing is focusing on reining in government debt and curbing financial risks. China has set a modest economic growth target of “above 6%” in 2021, is targeting a smaller fiscal deficit and has called on local governments to “tighten their belts.”
A number of economists and former advisers linked to China’s government say that focus is misplaced, given the shift in policy thinking globally since the Covid crisis as governments around the world pumped in record amounts of fiscal stimulus and central banks bought up the debt to keep interest rates low. It ties in with the growing popularity of Modern Monetary Theory, although none of the economists explicitly endorsed the approach.
“There’s a new understanding of debt in macroeconomics,” Liu Lei, a senior researcher at the National Institution for Finance and Development, a top government think tank, said in an interview. “Unlike the private sector, the government can continue to borrow new funds to repay old debts. The only requirement for this to go on is that interest rates remain low.”
Recent comments from U.S Treasury Secretary Janet Yellen placing more attention on debt service costs rather than total debt levels “makes a lot of sense,” he said.
Rising Debt Levels
A similar view was expressed by Zhong Zhengsheng, chief economist at Ping An Securities, who consulted with China’s Premier Li Keqiang on government policy last year. China should learn from the U.S. that close coordination between fiscal and monetary policy can be more important than financial stability, he said in an April speech.
China’s official government debt is low by international standards at more than 40% of GDP last year, but that doesn’t include large so-called hidden debts of local authorities held by off-balance sheet financing vehicles. Authorities vowed to reduce the total government debt-to-GDP ratio this year.
The International Monetary Fund estimates China’s general government fiscal deficit, which includes the central and local governments, will reach 9.6% of GDP this year, compared with 15% for the U.S.
China’s relatively under-powered stimulus comes against the backdrop of an economic recovery that’s moderating, leading some analysts to downgrade their growth forecasts for this year. In the U.S., GDP projections are being raised.
The divergent fiscal paths also has long-term implications, with the U.S. the only country forecast to have higher GDP by 2025 than predicted before the pandemic, according to projections from the Organisation for Economic Co-operation and Development and the International Monetary Fund. That could possibly delay the date at which China is set to overtake the U.S. in size.
What Bloomberg Economics Says...
“China’s government has its reason for less stimulus, given the recovery since 2H 2020. In other words, the recovery allows China to do so. The U.S. has a different situation from China, given that the economic recovery is lagging. In addition, I think most governments will consider reducing fiscal stimulus in the coming year when the pandemic is under control and their economies recover. China is just ahead of them.”
David Qu, China economist
Beijing’s conservative stance stems from its experience in the aftermath of the global financial crisis more than a decade ago, when it unleashed a stimulus blitz that fueled the economy’s expansion and saw debt levels race higher. Asset bubbles and wasteful investment stoked concerns of a “Minsky Moment,” where the market collapses because of unsustainable credit growth.
In 2016, President Xi Jinping’s top economic adviser Liu He led a shift to tighten credit in the economy, resulting in GDP growth moderating to 6% in 2019, before the pandemic struck. Although the government boosted spending and opened up the credit taps in early 2020, its fiscal stimulus was relatively modest compared to other major economies.
Having declared victory in the earlier de-leveraging campaign, policy makers can now moderate their stance on government debt, said Zhang Anyuan, a former researcher at a think tank affiliated with China’s top state planning agency.
“We should probably downplay the goal of reducing the absolute government leverage ratio, and place more focus on guiding interest rates to trend downward and ensuring that debts can be extended,” said Zhang, who is now chief economist at China Securities.
Latest data show a fiscal surplus in the first five months of the year as the government keeps tight control over spending, while borrowing by local governments has slowed.
The debt focus is hurting the economy by restricting the ability of local governments to invest more in infrastructure, according to Yu Yongding, a former adviser to China’s central bank.
“This year’s fiscal policy is materially tighter than last year. This is wrong,” he said. “We should not be in a rush to exit from stimulative policy.”
The central government should issue more debt to fund local spending, and buy local government bonds to lower interest rates if needed, he said. Mirroring the approach advocated by Modern Monetary Theory, Yu said inflation was the main constraint on policy, and its persistent low rate in China shows the economy has been growing below its potential.
Inflation reached 1.3% in May and has averaged 2.1% over past 5 years -- below the government’s ceiling of 3%.
Yu has been a critic of fiscal conservatism in China for years, but his views have gained little traction in Beijing. Officials explicitly rejected a proposal to implement quantitative easing by having China’s central bank directly buy government bonds last year.
“Why not use expansionary fiscal and monetary policy to make the growth rate higher?,” he said. “If you see a rising CPI and an increase in financial vulnerabilities, then you stop.”
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