Abstract: The author analyzes China’s path to economic recovery from the perspective of corporate, household, and government balance sheets. In terms of corporate balance sheets, there is a great divergence between large enterprises and SMEs. As for household balance sheets, the income of low- and middle-income groups hasn’t increased significantly. With respect to government balance sheets, from the perspective of general fiscal spending, the fiscal policy is not proactive enough. In general, China’s economy is on track to recovery, but balance sheet repair is not yet fully underway due to structural divergence.
I want to share my observations on the current economic data and the trend going forward from the perspective of balance sheets.
The reason for taking this perspective instead of simply interpreting the data in Q1 and April released by the National Bureau of Statistics is that this round of recovery differs a lot from the so-called cyclical recovery.
The pandemic-induced shocks to economic entities and the changes in balance sheets are different from the traditional boom-bust-recovery cyclical adjustment. Therefore, in this round of recovery, we should focus on how well are the balance sheets being repaired and the changes in expectations and endogenous momentum during the repairing process instead of simply basing the analysis on flow variables.
The Covid-19 pandemic over the past three years has dealt a heavy blow to the way our society works, the state of balance sheets, and people’s mindsets. Therefore, a short-term analysis must delve deeper into the stock variables and balance sheets.
I. CORPORATE BALANCE SHEETS: DIVERGENCE BETWEEN LARGE ENTERPRISES AND SMES
In terms of societal and transactional repair, or the first stage of recovery, data in May show that social activities have fully normalized, and transactions have demonstrated an upward trend, but the repair is not done yet. Most importantly, we haven’t moved into the second stage of recovery, including profit repair and then balance sheet repair.
Therefore, in the current special stage, the repair of balance sheets in the business sector has shown great divergence.
First, there is a clear divergence between large and small- and medium- enterprises (SMEs), especially micro- and small- enterprises. The overall profits of state-owned enterprises reached more than 1 trillion yuan in the first quarter of 2023, up 12.4% year-on-year, whereas SMEs, especially downstream SMEs and those in the service sector, not only did not see a full transaction repair but instead continued to suffer negative profit growth in the process of social reopening.
China's Micro- and Small-Enterprises Index, jointly compiled by Renmin University of China, Postal Savings Bank of China, and the Ministry of Industry and Information Technology, fell sharply after rebounding to a high level in February, and the operating performance of micro- and small-enterprises kept going downward in March and April. The official PMI of China’s small enterprises has been lower than the 50 threshold, and financial data concerning the overall operation also continued to deteriorate.
Second, the balance sheets of private enterprises, particularly those in the real estate sector, have not improved. Although the real estate sector lived through the worst funding situation last year and the most precarious period (from late 2022 to the 2023 spring festival), the sources of funds still fell in April. If the overall sources of funds grow negatively, it means that the sector’s balance sheets have not improved but are in a state of adjustment and deterioration. In other words, when real estate development is separated from the financial sector, the liquidity of real estate companies has been improved structurally, and the overall condition is still relatively poor.
Third, from the perspective of private companies, the massive funds that mostly flowed into state-owned enterprises haven’t significantly boosted recovery. Although the market sentiment turned for the better, it is still rather low. Therefore, it is natural for private companies to continue to suffer falling investments due to the lack of fundamental improvement in their balance sheets and profits.
In April, the growth of private investment dropped from 0.9% in late 2022 to 0.4%, indicating that the progress of China’s economic recovery and expansive policies haven’t fundamentally enhanced the profits and balance sheets of private companies, making it difficult to boost the expectations and momentum of the private sector.
From the divergence of the overall situation of enterprises and balance sheet improvement, we can see that the current policy enforcement is not strong enough to restart economic recovery fully, and the speed of policy transmission is slower than we thought.
II. HOUSEHOLD BALANCE SHEETS: THE INCOME OF LOW- AND MIDDLE-INCOME GROUPS HASN’T INCREASED SIGNIFICANTLY
The second type of balance sheet we should focus on is the household balance sheet. While household income in the first quarter of 2023 rose 5.1% year-on-year and 3.8% in real terms, the income growth of around 4% is not strong enough to boost the income of “key groups of consumers” and improve their balance sheets. This is because during the pandemic, the income of many low- and middle-income groups deteriorated, which can be seen from the falling share of their income in the total household income and GDP.
In other words, there is no significant improvement in the key driver of consumption - the low- and middle-income groups, which deserves our utmost attention.
More importantly, from a macro perspective, a 3.8% growth rate of household income in real terms is much lower than the 4.5% GDP growth. At this point, there is a contracting trend in the national income distribution, which means that a large amount of money is used for investment and not for consumption. This is because household income does not exceed national income, thereby leading to the contraction of their income distribution.
The phenomenon has occurred over the past three years. Once it happens, it might reduce the overall income, and then reduce demand, which will lead to lower prices and profits. As a result, a positive feedback loop between lower prices and lower income would be established, undermining the next stage of recovery.
Therefore, from a macro perspective, when household income growth lags far behind GDP growth, a more enterprise and government-oriented income distribution cannot strengthen the role of consumption in supporting the macroeconomy.
Among the low- and middle-income groups, there is indeed an increase in the employment rate and working hours of the marginal group (especially migrant workers). However, the employment of young people who lead consumption continues to fall, thereby dampening the overall consumption recovery.
Hence we need to watch the income growth, employment, and balance sheets of migrant workers and young people closely. Government policies have taken this into account and realized that consumption stimulus is not the focus, and using large-scale monetary stimulus to boost consumption is even less of an option. Instead, we are trying to repair and expand consumption based on increasing household income. Therefore, we have to take a medium-term perspective and devise short-term policies and adjust the corresponding medium-term expectations by building an effective mechanism for increasing the following four components of household income:
1. Wage Income
The wage income growth is relatively sluggish at the moment, which requires us to pay attention to the current wave of “salary cuts” in many industries. Given the current price decline, if “salary cuts” become a trend, the repair of expectations and consumption will be much harder. Hence we should avoid a downward price-income spiral. While the US is focusing on preventing the formation of an upward “price-wage” spiral, we should be concerned about the opposite issue.
2. Operating Income
The operating income of micro- and small- enterprises and business owners has dropped sharply. So how to increase support for SMEs when the sentiment of more and more SMEs is deteriorating? Although the State Council and local governments have introduced supportive follow-up policies, it is worth noting that the strength of the support should not diminish progressively but should be stepped up to some extent to help SMEs live through the difficult period.
3. Property Income
In my opinion, the stabilization and rebound of overall asset prices will help improve the household balance sheets; but the dual decline in “prices of goods” and “prices of financial assets” will add pressure to household expectations.
4. Transfer payment
In recent years, especially this year, transfer payment has grown much slower than the average level. This means that we need to step up the establishment of a government that is centered on improving people’s livelihood and adopt a more “proactive” policy of transfer payment while implementing proactive monetary policy, which is the key to social stability.
“Stabilizing transfer payment” and “stabilizing the social safety net” are fundamental to supporting income growth in the medium term. Household balance sheets have not improved (with only a 3.8% real growth rate) and even deteriorated (if structural factors are taken into account) for some marginal groups that play a supporting role in consumption, which deserves our utmost attention. At the moment, it is critical to put in place some programs to boost income growth in the medium term.
III. GOVERNMENT BALANCE SHEETS: FISCAL POLICY NEEDS TO BE REALLY PROACTIVE
The 3rd type of balance sheet is the government balance sheet. Fiscal revenue in the first quarter of 2023 has turned positive, which is an important sign and lays the foundation for China’s economic recovery.
Let’s we take into account the structural features, such as the difference between developed and inland regions, as well as the difference between the central government and local governments (for local governments, the difference between the provincial level and county level is considered). I think a positive revenue growth of about 0.6% is not enough to support a comprehensive improvement in the fiscal conditions of local governments.
The current issue is that some local governments in the central and western areas are constrained by debt, real estate slide, and economic sluggishness, and their tax revenue is still in negative territory despite the continued growth of non-tax revenue, leading to “ineffective implementation” of the government’s proactive fiscal policy. This is reflected in the fact that the real growth rate of general public budgetary spending plus expenditure on government-managed funds in the first quarter of 2023 was only 1%, far lower than the expected level of around 6%. Therefore, from the perspective of general fiscal spending, the fiscal policy is not proactive enough.
Given the “inactiveness” of the overall fiscal policy, structural constraints, and the deterioration of local governments’ (especially county-level) balance sheets, it is difficult for macro policies to be put in place at the local level and transmitted to micro entities. This requires fiscal policy to: first, speed up; second, be more accommodative; third, strengthen at the central level. The central government should play a greater role in stepping up fiscal support in the current transitioning stage.
Due to structural divergence, China’s economy is on track to recovery, but balance sheet repair is not yet fully underway. Therefore, it is normal to see a decline and fluctuations in some indicators in April and May. This also determines that in the process of transitioning towards the second stage of profit repair and balance sheet repair, the policy must focus on the changes in the balance sheets and the structural and behavioral divergence of different types of entities, so as to analyze the new mechanism, new phenomenon and new law of the current macro operation from a deeper level. In this way, we can analyze the new mechanisms, phenomena, and laws of macroeconomic operation at a deeper level and make policy adjustments accordingly.
The article is based on the author’s speech at the CMF monthly macro data analysis seminar in May, 2023. It was translated by CF40 and has not been reviewed by the author. The views expressed herein are the author’s own and do not represent those of CF40 or other organizations.
