Summary: At China’s current stage, it is crucial to address the debt repayment issues faced by the corporate sector and local governments. This includes not only default risks but also the downward pressure on aggregate demand caused by debtors being forced to cut spending to repay debts. China is in the middle of a financial cycle downturn, with insufficient endogenous demand momentum. Unlike the demand-driven downturn of the financial cycle in the United States, China’s downturn is triggered by a supply-side shock, necessitating appropriate counter-cyclical policy adjustments. Additionally, insufficient effective demand and the “decentralization” of global industrial chain adversely affect debt pressure alleviation.
During the debt risk resolution phase, risk appetite declines, and the demand for safe assets increases, but the endogenous supply of safe assets faces downward pressure. M2 (bank deposits) constitutes the main portion of safe assets for Chinese households and businesses, and recent weak credit demand has led to a decline in M2 growth. To address the issues of insufficient effective demand on the real economy side and weak risk appetite on the financial side, the key to macro counter-cyclical adjustment lies in fiscal expansion.
China can approach debt resolution from the sides of new and existing debt. On the side of new debt, the central government can moderately increase debt, as government debt represents assets for the current generation, and an increase in government debt corresponds to an increase in the net assets of corporate and household sectors, thereby aiding in their deleveraging. On the existing debt side, debt restructuring aimed at extending maturities and lowering interest rates can reduce the current repayment burden.
Finally, different macro policy tools and transmission channels are constrained to varying degrees by the market. Promoting demand through interest rate reductions may be constrained by exchange rates, while the speed and extent of risk premium decline are influenced by the macro environment, including debt resolution progress itself and geopolitical factors. In summary, under the current circumstances, the exogeneity and counter-cyclicality of central government debt make it the most effective tool for addressing insufficient aggregate demand and mitigating debt risks.
