Why China can’t afford to tighten economic policy just yet
- China’s growth in 2020 was driven by fixed-asset investment and exports. This is not ideal
- To achieve higher growth in 2021, China needs a larger increase in infrastructure investment, and the government may have to issue more bonds than planned
According to the Ministry of Finance, general budget revenues will increase by 8.1 per cent this year, while general budget expenditure will grow by just 1.8 per cent. It is rare for government spending to grow so much more slowly than budget revenues.
And although the government’s planned issuance in 2021 of 7.2 trillion yuan (US$1.1 trillion) in bonds is still high, it is materially smaller than the 8.5 trillion yuan it issued last year. At the same time, the People’s Bank of China is likely to maintain its monetary policy stance, if not tighten it.
The Chinese government’s cautious attitude towards expansionary macroeconomic policy reflects its vigilance regarding inflation and financial risks – especially the latter. Though inflation may worsen somewhat in the near future, it is unlikely to be economically destabilising.
While China should pay great attention to the problem of high leverage ratios, its financial vulnerability has been exaggerated. It is difficult to imagine how a high-saving, high-growth economy, with huge state-owned assets at its disposal and limited foreign debt, can be brought down by a systemic financial crisis resulting from high leverage ratios.
In my view, therefore, China’s macroeconomic policy in 2021 should focus on boosting growth in line with the economy’s potential growth rate, rather than on stabilising or lowering leverage ratios. Assuming that China’s potential growth rate is 6 per cent, back-of-the-envelope calculations show that, taking the base effect into consideration, the economy should expand by more than 8 per cent this year.
In fact, household spending growth, in terms of total retail sales of social consumer goods, weakened in the first two months of 2021. Moreover, exports will probably contribute less to China’s GDP growth in 2021 than they did last year, owing to the global economic recovery and base effects.
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So, to compensate for the aggregate demand shortfall, the government has no alternative but to use expansionary fiscal and monetary policy to support infrastructure investment. In 2020, infrastructure investment grew by just 0.9 per cent, compared to more than 40 per cent in 2009.
Whether a government’s budgetary plan is appropriate depends on the country’s indicative or mandatory growth target. To achieve annual growth of 8 per cent in 2021, China needs a much larger increase in infrastructure investment than last year. Furthermore, such investment should be financed directly through government budgets rather than by bank loans to subnational authorities.
In 2021, the government may need to issue more bonds than planned, and the PBOC may need to lower the interest rate to facilitate this – if necessary, by going so far as to implement a variant of quantitative easing.
Needless to say, macroeconomic policy alone will not be enough. The authorities should implement many more structural reforms so that all economic actors, especially local governments, have the right incentives to respond actively and reasonably to stimulus measures. But to consolidate its post-pandemic growth momentum in 2021, China should not be in a hurry to exit from expansionary fiscal and monetary policy.
Yu Yongding, a former president of the China Society of World Economics and director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences, served on the Monetary Policy Committee of the People’s Bank of China from 2004 to 2006. Copyright: Project Syndicate