Abstract: China’s economy is expected to witness a robust rebound in 2023 for two main reasons: first, there is considerable room for China to implement expansionary macroeconomic policy; second, the base numbers in 2022 were rather low. The ultimate way of reversing expectations is to get economic growth back to the pre-pandemic trendline. To that end, China should balance the tradeoff between consumption and investment. Consumption can only boost growth in the short run when effective demand is insufficient, while investment can stimulate demand in the short term and drive economic growth in the future. Infrastructure investment should still and can play a key role in achieving high GDP growth.
I. TO BOOST SENTIMENT, THE TARGET FOR GDP GROWTH COULD BE SET AT 6%.
Q: What is your outlook for China’s economy in 2023? What are the main drivers of economic growth?
Yu: China’s economy in 2023 faces huge uncertainty mainly because we don’t know how the COVID-19 pandemic would evolve, just as we didn’t anticipate the development of many things since October 2022. If the pandemic can be brought under control, China’s economic growth in 2023 is expected to witness a robust rebound, for two main reasons: first, there is considerable room for China to implement expansionary macroeconomic policy; second, the base number in 2022 was rather low. With the optimization of China’s pandemic control policy, it is not surprising for foreign investment banks to revise up their estimates for China’s GDP growth in 2023, though I couldn’t give an estimate because I don’t have econometric model at hand.
China’s GDP growth in 2019, 2020, and 2021 was 6%, 2.2%, and 8.1%, respectively, averaging about 5.4%. The Chinese government set the growth target for 2022 at around 5%-5.5%, likely based on the three-year-average from 2019 to 2021.
In 2022, China’s GDP growth reached 3%. If China’s potential GDP growth is 5%, given the low base of 2022, GDP growth in 2023 might hit 7%. But it should be noted that the potential growth rate, one that China can reach without fueling inflation, might have declined sharply. If the potential growth rate stands at 4%, then China’s economic growth in 2023 should be 5%; if the potential growth rate is 4.5%, then the economic growth in 2023 should be 6%. Here, I’m only doing a simplified calculation, not a forecast. Based on this simplified analysis, the growth rate China might reach in 2023 is related not only to the base effect but also to China’s potential growth rate.
Therefore, in the absence of any “black swan” or “quasi-black swan” events, it is not difficult for China’s growth rate to exceed 5% in 2023. To boost confidence, it is ok to set a 6% growth target.
When it comes to the main drivers of economic growth, we have to look at the “troika” of consumption, investment, and net export, a cliché but standard way of analysis. Domestically or internationally, if we are going to discuss how to employ macroeconomic policy to regulate the economy, it is necessary to explore how to strike a balance among these three drivers.
There is no doubt that stimulating consumption can boost the economy in the short term. The fact that the US economy recovered rapidly from the pandemic has something to do with the fiscal relief program adopted in 2020. As for China, though it needs to resume the growth of consumer demand, the effectiveness of directly stimulating consumption is highly uncertain. While consumers may indulge in a fit of “revenge spending”, they are unlikely to continue to increase consumption in the absence of more income or better income expectations. Many scholars proposed solutions like issuing consumer vouchers or providing direct subsidies. These measures are necessary for helping the poor and maintaining social stability and could be adopted by local governments based on their local conditions. However, as a macroeconomic policy to boost economic growth, methods like issuing consumer vouchers might only play a limited role in stimulating consumption.
If income expectations are not improved, households might convert the abnormal extra income into savings (for example, they could deposit the money saved from using vouchers into bank accounts). According to the financial data of the People’s Bank of China (PBC), in the first three quarters of 2022, China’s household deposits increased by 13.21 trillion yuan, 4.72 trillion higher than the same period in 2021. Throughout 2022, RMB deposits climbed by 26.26 trillion yuan, an increase of 6.59 trillion compared with the previous year. Of the total amount, deposits from households rose by 17.84 trillion yuan, way higher than the increase of 9.9 trillion yuan in 2021, hitting a record level.
Although the increase of household deposits does not necessarily mean the rise of household savings, it is indisputable that household propensity to consume has declined and the savings rate of households has increased. This is to be expected. In fact, it would be abnormal to be otherwise. I agree with the view that at least part of the increase of household deposits comes from precautionary savings. With the optimization of the pandemic control policy, some of these savings will be transferred into consumption. But the key for continuous growth of consumer demand lies in whether the goal of steady GDP growth could be reached. Only when the economy grows and household income rises can the households’ income expectations be improved and consumer demand climbs steadily.
The prospect of China’s export in 2023 is very uncertain. Given the gloomy global economic outlook in 2023, China’s export growth can hardly be a major driver of economic growth in 2023. Besides, to realize the dual circulation development strategy, China must be determined to further adjust export policy to optimize the cross-border resource allocation instead of taking measures that distort the market, such as boosting export by raising export tax rebate rate and depreciating RMB. Under normal circumstances, China should maintain a certain level of trade deficit for a period of time and reduce foreign exchange reserves. This does not mean that China is giving up overseas market. Instead, this is to create a level playing field for companies, whether export-oriented or not. Chinese companies should gain foreign market by their own competitive advantages rather than relying on incentives like higher export tax rebate rate which distort the market.
Among the “troika”, investment mainly includes manufacturing, real estate, and infrastructure investment. Manufacturing investment depends on the macroeconomic condition and is decided by the market and entrepreneurs based on the objective law of technological development and industrial upgrading. Some young economists familiar with industrial economy pointed out that among newly added manufacturing investment, investment in technological upgrading accounts for around 40%, up by 5-10% compared with a decade ago. Given that effective demand is not sufficient, now is the best time for companies to conduct technological upgrading. As part of the expansionary macroeconomic policy, interest subsidies can be provided by the government in addition to tax cuts so as to support and incentivize businesses to invest in necessary technological upgrading, which should be done sooner rather than later. There are many investable projects. For example, upgrading production lines in energy-intensive industries that fail to meet the unit emission standards and establishing solid waste disposal bases. I hope these suggestions will be taken seriously by the government.
The rise and fall of real estate investment have their own pattern. When designing policies targeting the real estate industry, the government should take a long-term view and ensure the consistency and continuity of policies instead of making constant changes or using real estate investment as a macroeconomic policy tool to boost economic growth or cool overheated economy.
Unlike manufacturing and real estate investment, infrastructure investment is a public good, which is and can only be dominated by the government. The best time to invest in infrastructure is during an economic downturn. Besides providing public goods, infrastructure investment can also cushion the negative impacts of declining real estate investment on economic growth and boost manufacturing investment. Infrastructure investment can also stimulate consumption. For example. Infrastructure investment can increase the income of migrant workers, thereby enabling and encouraging them to spend more. In sum, the implementation of China’s expansionary macroeconomic policy in 2023 still needs to be driven by infrastructure investment.
Our understanding of infrastructure should not be confined to “railway, road, and airport”, or even the difference between “new infrastructure” and “old infrastructure”. China does not have the problem of overinvesting in infrastructure. The COVID-19 pandemic over the last 3 years has laid bare China’s lack of investment in infrastructure related to medical care and pandemic prevention and control. On a per capita basis, the investment gap in infrastructure is even larger. There is indeed huge waste in infrastructure investment and we should design a mechanism to avoid the waste beforehand and hold people accountable afterward. But these are issues of how infrastructure should be built, not whether infrastructure should be built at all.
Many scholars are shy of talking about the role of investment in driving economic growth, and the idea of increasing the share of consumption in GDP becomes a type of “political correctness”. In my opinion, we should balance the tradeoff between consumption and investment and distinguish different roles of consumption and investment in driving economic growth in the immediate term and in the long term. The ultimate goal of human economic activities is consumption and consumption is related to people’s well-being. People would not defer consumption to the distant future, as they did in the era of planned economy. The choice between consumption and investment is also the choice between spending more at the moment and spending more in the future. This is related to public preference and also geopolitical issues. Consumption bolsters economic growth only in the short term and when effective demand is not adequate. It contributes to GDP growth mainly by enabling the economy to achieve full employment and fully utilize production capacity in the current period. Consumption does not increase the growth potential of an economy unless it is associated with an increase in human capital.
Unlike consumption, investment has a dual-role to play. Investment can stimulate demand in the short term and boost economic growth in the long-term future. In the past, China did have extremely low consumption rate and high investment rate, making it necessary to reduce investment rate. But in recent years, investment rate has fallen too fast, which has made considerable impact on China’s growth potential. In 2019, China’s investment rate was 43%, still higher than other countries. However, caution is advised when deciding whether China’s investment rate is excessively high or not. For example, according to the National Bureau of Statistics, China’s investment in real estate development accounted for 27.1% of fixed-asset investment, way higher than other countries. Unlike manufacturing and infrastructure investment, investment in real estate development generally does not produce capital goods, improve the level of per capita capital equipment, increase productivity, or raise future per capita GDP. Therefore, these factors should be taken into account when comparing China’s investment rate with that of other countries.
II. THE ULTIMATE WAY OF REVERSING EXPECTATIONS IS TO GET ECONOMIC GROWTH BACK TO THE PRE-PANDEMIC TRENDLINE
Q: China’s economy is facing the triple pressures of demand contraction, supply shocks, and weakening expectations. Will these pressures diminish in 2023?
Yu: Since 2020, China’s economic condition has been characterized by pandemic-induced dual shocks from both the supply and demand sides. In this case, the right policy response is to repair the supply chains damaged by the pandemic and adopt expansionary macroeconomic policy to recover the aggregate demand to the pre-pandemic level. During the 2 years after the outbreak of the pandemic, macroeconomic policy could only play a constrained role and the supply chains could not be completely repaired. As a result, output could hardly increase, and neither could economic growth. Facing the dual shocks of supply and demand, economic growth will inevitably decline, but whether prices go up or down depends on the relative impact of these two shocks. What we had in the previous period was a sharp decline in economic growth absent significant price increases due to greater demand shock. With the optimization of pandemic control, if expansionary macroeconomic policy is adopted on the one hand and the supply chains are repaired through various measures based on the pandemic condition on the other hand, China can overcome the supply and demand shocks and get economic growth back to the pre-pandemic trendline.
The “weakening expectations” described by the central government refers to the weakening expectations about China's economic growth prospects, e.g. income growth and employment prospects. Weakening expectations are causally related to demand and supply shocks, but the two are not the same thing in nature. Weakening expectations must be understood in two phases with the outbreak of the pandemic as the dividing point. Before the pandemic, China's GDP growth had been falling quarter by quarter since 2010, from 12.2% in Q1 2010 to 6% in Q4 2019. Some believed that China's potential growth had already fallen below 6%, so that GDP growth would fall further. At that time, there was a debate over whether China should keep its growth rate at 6%, which was a reflection of the weakening expectations. However, with the outbreak of the pandemic, and its disruption of the supply chains and suppression of demand, the already weakened expectations have further deteriorated, which in turn hindered the recovery of supply and demand, especially the latter. To me, the fundamental way to improve expectations is to reverse the trend of economic slowdown and bring the growth back to a level of around 6%.
Of course, concerns over intellectual property protection and the rule of law also affect expectations. Though they fall outside the scope of macroeconomic policy, their importance are self-evident.
III. RESTRUCTURE INFRASTRUCTURE FINANCING
Q: How much did infrastructure contribute to economy growth in 2022? How much room is there for infrastructure investment to contribute in 2023? What role can infrastructure play in expanding domestic demand and stabilizing growth?
Yu: The year of 2022 recorded a year-on-year growth in infrastructure investment of 9.4%, making positive contribution to China's economic growth. However, it must be noted that this growth rate is more or less a result of the low base of the previous year. Year-on-year growth of infrastructure investment of 2018, 2019, 2020 and 2021 are 3.8%, 3.8%, 0.9% and 0.4% respectively. Historically, the annual growth of infrastructure investment in China hovered around 30% before the global financial crisis in 2018. While a too rapid growth of infrastructure investment is certainly undesirable, the speed of decline in the growth after 2018 is rather alarming. (Note: In 2018, the statistics department corrected the data of infrastructure investment, but this barely affects the authenticity of the statistics after 2018.) In 2023, in the face of the grim international economic situation and the uncertainty of consumption demand at home, infrastructure investment should and can play a key role to ensure a higher growth rate of GDP.
The financing structure of infrastructure projects in China features the over-reliance on market-oriented and high-cost funding for low-yield or even no-yield infrastructure projects that have the attributes of public goods and generate low or zero cash flow. For example, in 2021 the funds raised by urban investment companies accounted for 55.7% of the funding for infrastructure projects, meaning that funds bearing the highest interest rate take up the largest share in infrastructure financing. It is roughly the same case in 2022. The structure of infrastructure financing has shifted the fiscal and financial risks of the country’s expansionary fiscal policy from the central government to the local level. However, fiscal and financial risks facing the country have not been reduced but rather increased due to the complexity and opacity of this financing structure and the rising cost of funding and management. The high level of local government debt is not only caused by local governments, but also the unhealthy financing structure.
How should China change its financing structure of infrastructure projects? First, China needs to bolster general public budget support for infrastructure investment so as to change the situation where the central general public budget accounts for too small a share in infrastructure financing. Second, more transfer payments from the central government's general public budget to local governments are needed to provide subsidized loans for infrastructure projects. Third, restrictions on the issuance of special bonds should be relaxed. While projects should be strictly reviewed, financing conditions for qualified projects should be relaxed. Efforts should be made to reduce red tape and improve the efficiency of special bonds. Fourth, restrictions on purchasing urban investment bonds should be moderately relaxed to give financial institutions, especially commercial banks, greater autonomy. Fifth, financial innovation should be encouraged to explore new channels for infrastructure financing. Sixth, the government should implement loose monetary policy and reduce financing costs of infrastructure projects to support the expansionary fiscal policy.
As for local government debt, we should recognize the fact that despite the high level of local government debt, China's total government debt as a percentage of GDP is much smaller than that of the United States and Japan. Boasting a high level of savings, China is fully capable of resolving the debt issue of local governments as long as debt treatment does not disrupt the normal operation of the real economy.
IV. REAL ESTATE SECTOR MAY HAVE PASSED THE MOST DANGEROUS STAGE
Q: How do you see the prospect for China's real estate market in 2023 and its impact on economic growth? Which areas need the bailout policies most?
Yu: According to data from the National Bureau of Statistics, the sales prices of newly-built commercial housing in Tier 1 cities rose year on year by 2.5% in December 2022, same as the previous month; the sales prices in Tier 2 cities fell by 1.1% year on year, 0.1 percentage point less compared to the previous month; the sales prices in Tier 3 and Tier 4 cities fell by 3.9% and 4.8%, the same as the previous month. The year-on-year increase in sales prices in first-tier cities indicates that the worst moment of real estate risks may have passed.
However, for the full year of 2022, real estate investment nationwide fell by 10.0% year on year, of which, residential investment fell by 9.5%, seeing an accelerated decline compared to the cumulative growth rate in previous months. The total floor area sold and the volume of sales both suffered continuous and sharp decline at double-digit rates, with no clear signs of slowing down. In addition, funds in place for real estate enterprises fell by 25.9% year on year, with domestic loans down by 25.4%, personal mortgages down by 26.5%, and down payment and advance receipts down by 33.3%. All together, these figures make for a less than optimistic outlook for China's real estate market in 2023.
The real estate sector was defined as a pillar industry in China in 2003, and home prices have largely been on the rise since then. The Bank for International Settlements (BIS) house price index rose from 75.95 in 2005 to 145.91 in 2021, while according to the World Bank, China's real estate sector is the main engine fueling the country’s economic growth. By the end of 2021, China's real estate investment accounted for 13% of GDP, while the share was 5% in OECD countries; when supply chain inputs are considered, the share would rise to 30%. For the government, the challenge is to balance the needs of stabilizing real estate prices to meet public demand for housing on the one hand, and preventing real estate investment volatilities from affecting macroeconomic stability on the other.
For example, in Q3 2008, the Chinese government introduced a stimulus package of four trillion yuan and implemented an ultra-easy monetary policy to hedge against the impact of the global financial crisis on China's exports. As a consequence, house prices began to soar in Q1 2009 and hit a record high in Q2 2010. To control the surge in housing prices, real estate regulation polies were introduced in October 2009 and the deposit reserve ratio was raised 12 times from January 2010 to June 2011. The real estate regulation policies aimed at curbing the rise in housing prices were not fully consistent with the macroeconomic policy objective of maintaining stable economic growth. It can be said it was the real estate regulation after October 2009 that triggered the process of quarterly decline of China’s GDP growth.
Another example is the sharp reduction in the policy interest rate in 2020. The abundant liquidity caused the housing prices to rise despite the spread of the pandemic. In order to stabilize housing prices, the central bank and the CBRC among other departments came up with the "three red lines" in August 2020 to regulate the financing activities of real estate enterprises. The growth of real estate investment fell sharply from 38% in January-February 2021 to 4.4% late that year, and the cumulative growth rate of real estate investment fell further to -10.0% in 2022. The rapid decline in the growth of real estate investment seriously prevented the country from achieving its growth target in 2022.
Commercial housing assumes the dual attributes of durable consumer goods and investment goods. As consumer goods, housing prices depend on the supply and demand in the real estate market. As investment goods, housing prices can be influenced by speculative activities. Once monetary policy is loosened, housing speculators are always the first to act. In fact, the soaring house prices in some cities in 2020 are largely a result of speculation. In times of economic downturn, it is necessary to implement loose monetary policy, which, however, breeds speculative activities. In the long run, we must push through with the housing system reform; while in the short term, we need to rely more on fiscal policies and other means to curb speculative activities. It is essential to distinguish the goals of robust economic growth and stable housing prices. Efforts to stabilize housing prices should not be a drag on economic growth. Real estate policies should aim at long-term development, and never be easily changed due to short-term economic fluctuations. During an economic downturn, supporting real estate investment growth is as important as stabilizing real estate prices.
The risk of China's real estate sector lies not in the bankruptcy of financial institutions due to asset bubble burst (as in the case of Sumitomo in Japan and the subprime mortgage crisis in the US) thanks to the country’s strict regulation of home mortgages, but in the over-reliance of real estate development on revenues from presales (taking up about 51%) and self-financing. When housing prices fall, real estate developers face liquidity shortages as a result of delayed payments of receivables and restricted access to financing, which can easily affect the real economy and homebuyers. Efforts to ensure timely delivery of presold homes are necessary as they can protect homebuyers to the most. Commercial banks can provide liquidity support to help bail developers out. When a real estate developer that can pose systemic risk is on the verge of bankruptcy due to insolvency, in addition to debt restructuring, one more option is to allow these enterprises to be temporarily nationalized by the government and state-owned enterprises.
Now that housing prices have stabilized, real estate investment is expected to see positive growth after some time. However, I’m afraid that the era of real estate investment-driven economic growth has become history.
V. CHINA MUST BE FULLY PREPARED AGAINST INFLATION PRESSURE
Q: How do you see the inflation pressure facing China in 2023?
Yu: That China can implement expansionary fiscal and monetary policies is mainly because of the country’s low inflation rate over the past decade. Keeping inflation at a low level is a very important condition for China to maintain expansionary macroeconomic policies and strive for higher economic growth rates.
It is highly possible that inflation in China will rise in 2023. First, even if black swan events are not considered, the supply chains in China may take longer than expected to fully recover. The recovery in consumer demand is likely to come sooner than in supply. Second, expansionary fiscal and monetary policies and the monetization of fiscal deficits will create some inflationary pressure. Third, counter-globalization, the US-China trade conflict, global supply chain disruptions, and rising food and energy prices due to the Russia-Ukraine conflict will bring imported inflation to China. Fourth, the RMB may suffer another round of devaluation, which will generate inflationary pressure.
Therefore, we should be fully prepared for inflationary pressures in 2023 while also acknowledging the need to tolerate relatively high inflation for a certain period of time for the sake of economic growth. The government may need to set an inflation target for 2023 to limit the easing of macroeconomic policies and make preparations at the industrial and micro levels to ensure an adequate supply of food and other daily consumer goods.
Ⅵ. THE RMB DEPRECIATION THAT STARTED IN 2022H2 MAY BE COMING TO AN END.
Q: 2022 has witnessed fluctuating RMB exchange rates. What are your thoughts on the pressures of RMB depreciation in 2023?
Yu: China had enjoyed a "double surplus" for a long time, but since 2015, financial and capital accounts have been in deficit. The pressure of exchange rate depreciation mainly comes from the financial and capital account deficit and the outflow of funds under net errors and omissions.
Capital outflows are caused by three major factors. First, expectations are worsening as a result of domestic economic and financial deterioration. For example, China's economy performed poorly in 2015. The stock market crashed, economic growth slowed to its slowest rate in 25 years, market expectations for RMB depreciation were high, and capital outflows were severe. The second factor is not economic. For example, trade tensions between the United States and China in 2018-2019 had a significant impact on the exchange rate. Third, there are short-term activities like arbitrage. The main reason for this round of RMB depreciation against the US dollar beginning in 2022H2 was interest rate hikes by the Fed, which widened the interest rate spread between China and the US.
Since 2020, the pressure on RMB depreciation has been primarily pandemic-related, China's economic growth expectations, and the Fed's monetary policy. After Q2 2022, RMB depreciation is primarily due to Fed rate hikes and a narrowing of the interest rate differential between China and the US.
International factors also have an impact on the RMB exchange rate, and these common factors can be reflected by the rise and fall of the US dollar index. Experience has shown that the depreciation of the RMB and changes in the US dollar index have a mirror-image relationship—that is, they move in the opposite direction. When analyzing and judging the RMB exchange rate, we must also consider the trend of the US dollar index. In some ways, China's splurging of foreign exchange reserves to combat depreciation from 2015 to 2016 made little difference. The US dollar index began to fall sharply in 2017, and almost all currencies around the world appreciated against the US dollar. If we had not intervened and allowed the RMB to depreciate, I believe it would have stopped falling and recovered by the end of 2016.
We should learn to adapt to fluctuations in the RMB exchange rate and not become overly concerned just because the RMB-US dollar exchange rate is approaching a certain threshold.
PBC’s exchange rate policy in 2022 can be summed up as "benign neglect". The central bank did not appear to intervene directly in the currency market. It worked out well. This policy does not imply that there will be no intervention under any circumstances. The change in exchange rates is a self-balancing mechanism, and the central bank should intervene in the market only under exceptional circumstances.
Given the Fed's policy stance and China's domestic economic outlook, this round of RMB depreciation may be nearing its end. Many concerns, such as recession and stagflation, will limit the Fed's hikes in 2023 to be milder and less frequent. Investors' expectations for China's economy will rise significantly. Even if the RMB depreciates again, the current round of depreciation, which began in the second half of 2022, may be over.
Ⅶ. IMPLEMENT FISCAL-CENTERED EXPANSIONARY POLICIES AND DEEPEN ECONOMIC SYSTEM REFORM
Q: What are the most effective methods for increasing domestic demand? How much room is there for implementing expansionary fiscal and monetary policies?
Yu: Comprehensive measures are required in the face of weak domestic demand. From a macroeconomic standpoint, expansionary fiscal policy is the primary policy tool. We may face great fiscal challenge in 2023.
The national general public budget deficit for 2022 is 3.37 trillion yuan, and 3.65 trillion yuan of special local government debt was issued. It is fair to say that the budget arrangement at the beginning of the year made sense, but unfortunately, COVID disrupted the implementation of the fiscal plan. On the one hand, decreased tax revenue due to economic slowdown, sharp decline in the revenue from land grants and property-related taxes due to the downturn in the real estate market, and tax reduction measures such as VAT retention and export tax rebates, together put a huge dent in fiscal earnings. On the other hand, increased pandemic control spending added to the debt service burden of local governments. Our team estimate that China's fiscal revenue and expenditure gap in 2022 will most likely exceed the budgetary arrangement at the beginning of the year. Some estimates put the combined revenue and expenditure gap at around 2 trillion yuan, while others put the estimate at over 3 trillion yuan.
There are three ways to solve the gap: 1) reducing expenditure and increasing income, 2) allocating funds, and 3) issuing additional government bonds. None of them are easy. Usually, when making a budget, the previous year's adjustment and stabilization fund or other budget items would be transferred into the current year, and the budget gap would be calculated accordingly to determine the amount of new government bonds, special bonds and special government bonds to be issued. It is conceivable that there may be little room for such horizontal transfer in 2023. It will be challenging to organize a 2023 budget that ensures an economic growth rate of more than 5.5%. Instead of robbing Peter to pay Paul, it would be better to simply increase the general public budget deficit.
China’s local debt remains a prominent problem, but according to the IMF, the Chinese government debt (central & local) to GDP ratio is 71.5% (October 2021), compared with 262% in Japan, 151% in Italy, 137% in the US, 118% in Spain, 118% in Singapore, 113% in Canada, 113% in France, 95.6% in the Eurozone, and 69.3% in Germany. Given its high savings rate and good balance of payments, China has more room for expansionary fiscal policy than most developed countries. I think that China's fiscal deficit/GDP ratio will need to be much higher in 2023. There is no need for China to strictly keep this number within the Maastricht reference value of 3%. As long as economic growth is ensured, increasing the fiscal deficit and the fiscal deficit/GDP ratio should do more good than harm.
To cover the fiscal deficit, the government may need to increase government bond issuance in 2023. The preferred target for these bonds is primarily the general public and secondarily the financial institutions. The central bank, in turn, must maintain low-interest rates to create a favorable environment for government bond issuance. 750 billion of special government bonds were issued by the Ministry of Finance on December 12, 2022. According to its treasury department , "The Ministry of Finance has decided to issue the 2022 Special Government Bonds to raise financial resources for the national economy and social undertakings. The special government bonds will be issued in the national interbank bond market to specific domestic banks, and the PBC will carry out open market operations for these banks." This operation is widely considered to be an "extension”, but some reckon it to be a "QE". Arguments aside, there is no doubt about the rationality of this operation. If there is no better option, a repeat of the operation in 2023 may be necessary.
The effectiveness of monetary policy is limited by weak demand, but there is still room for expansionary monetary policy in China. The average RRR for financial institutions in China, the most important monetary policy tool, is around 7.8%, while in the US it has been reduced to 0% since March 2020. Various other policy interest rates in China such as R007 at around 2% and the medium-term (1-year) MLF interest rate at 2.75% also have room for further reduction. China's experience over the past few decades shows that monetary tightening can be effective in managing an overheated economy, but in a sluggish economy the effectiveness of monetary policy is often constrained by the so-called "pushing-on-a-string effect". However, a CF40 study found that a 1 percentage point reduction in the policy rate could reduce the principal and interest payments by 774 billion yuan, reduce earnings on deposits and wealth management products by 655.2 billion yuan and increase net cash flow by 118.8 billion yuan for the residential sector every year; reduce interest costs by 1259.9 billion yuan, reduce interest earnings on deposits by 315.7 billion yuan and increase net cash flow by 944.2 billion yuan for the business sector; reduce interest payments by 159.7 billion yuan, reduce interest earnings on deposits by 34.9 billion yuan, and increase net cash flow by 124.8 billion yuan for the government sector; and boost nominal GDP growth by 1.2 percentage points. This shows that an accommodative monetary policy can play a positive role in achieving stable growth.
In particular, monetary policy should play an active role in helping SMEs repair their supply chains and resume normal business operations so that they do not close down due to liquidity shortages. On the other hand, it should also learn from the lessons of the "four trillion" period and refrain from adopting a non-market-based approach of imposing credit disbursement targets and forcing commercial banks to issue more credit.
Having discussed the necessity and possibility of expansionary fiscal and monetary policies for the highest possible economic growth rate, I want to emphasize that the government must also deepen the reform of the economic system, especially by strengthening the protection of property rights of non-public enterprises and the rule of law, and continue to implement the various reform measures formulated during the Third Plenary Session of the 18th Central Committee. In a sense, the implementation of expansionary macroeconomic policies to stimulate economic growth only buys time for reforms and adjustments. If we delay the necessary reforms and adjustments and sit on our hands until inflation deteriorates severely, the room for applying expansionary macroeconomic policies will be lost, and the economy may face stagflationary difficulties.
I believe that as long as China persists in reform and opening-up, continues to improve its COVID policies, and adheres to expansionary fiscal and monetary policies, the country will be able to overcome its current difficulties and achieve "stable growth", thus ensuring the achievement of the "two centuries" modernization goal.
This article was released on CF40’s WeChat blog on January 18, 2023. The views expressed herewith are the author’s own and do not represent those of CF40 or other organizations. It is translated by CF40 and has not been reviewed by the author.
