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China’s Mid-Year Budget Expansion and Its Implications
On October 24, 2023, the Standing Committee of China’s National People’s Congress (NPC) authorized a mid-year expansion of the Central budget, increasing it by RMB 1 trillion (0.8% of GDP). This additional funding, which is expected to boost infrastructure capital expenditure (capex), will be divided equally between the fourth quarter of 2023 and 2024.
This budget adjustment in the middle of the year, along with an increase in the on-budget fiscal deficit ratio to above 3% — usually considered a red line — is a rare move. The last cycle of such budget expansion occurred from 1998 to 2000, when the budget was expanded for three consecutive years. This happened after China had experienced an economic slowdown due to the Asian Financial Crisis and flooding disasters, and it preceded the introduction of China’s land-fiscal model and its entry into the World Trade Organization. The political signal it sends seems to outshine the number itself. While RMB 1 trillion is not significant compared to China’s GDP of RMB 121 trillion, it suggests that the government is aware of the inefficacies of recent policy loosening and is poised to do more, shifting from the deleveraging focus of the first half of the year.
A Surprising Scale of Stimulus
The expansion involves issuing special central government bonds of RMB 1 trillion in Q4, on top of the originally planned fiscal deficit of RMB 3.88 trillion. The additional bonds, equivalent to 0.8% of GDP, will be transferred to local governments. The proceeds will be used primarily for post-disaster recovery and infrastructure investments.
The fiscal deficit would then be 3.8%, higher than the 3% in normal years and even higher than the COVID outbreak year of 3.7%. This suggests a strong commitment from the government to support growth. It is as much a statement as it is a stimulus, indicating that the fiscal contraction cycle is likely behind us.
Key Stimuli in 2023
This year, China’s policymakers have provided a lot of monetary support, such as lowering interest rates, reducing reserve requirement ratios, and injecting liquidity into the capital market via sovereign wealth funds. Yet, we believe fiscal policy is more crucial because property and local government debt issues are not easily addressed through monetary policies.
The additional RMB 1 trillion government bond issue is considered fiscal stimulus, mainly transferring fiscal budgets from the central government to local governments. There has also been a notable increase in municipal bond swaps to help local governments refinance their debts. These moves give local governments more budgets to invest in the real economy, including infrastructure and property. These fiscal policies are more effective in restoring confidence, reducing the need for precautionary household savings, and subsequently boosting consumer sentiment.
A Note on US-China Relations
In addition to these fiscal policies, it’s essential to highlight recent developments in US-China relations. The first US-China economic working committee meeting was held recently, and China’s Foreign Minister Wang Yi has visited the US, presumably to finalize a meeting between Presidents Xi and Biden.
These moves, coupled with potential changes in US policy towards semiconductor bans on Huawei-related companies, suggest a fine-tuning of the US-China decoupling/cold war trend. If the Biden-Xi meeting can achieve results and establish a clear understanding between the two sides, it could significantly boost market sentiment.
Final Thoughts: A Positive Shift in Fiscal Strategy
In conclusion, China’s mid-year budget expansion signals a significant shift in its fiscal strategy. The decision to issue additional central government bonds reflects a proactive approach to stimulate economic growth and indicates a commitment to overcoming recent policy inefficacies. While the immediate market response may be muted, the long-term prospects for economic stability and growth are encouraging. The combination of fiscal stimulus, debt refinancing, and a potential thaw in US-China relations could create a more favorable environment for investors, particularly in state-owned enterprises. Despite the uncertainties, the fiscal contraction cycle appears to be behind us, marking a new phase of fiscal expansion and economic rejuvenation.
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