China’s budget deficit
The fiscal hole is much bigger than meets the eye—but under control
IF A country’s fiscal deficit hit 10% of GDP five years running, you might reasonably conclude that its public finances were parlous. So it is understandable that China has bristled at suggestions that it is veering into such territory. Officially, China is a paragon of fiscal rectitude: its annual deficits have averaged just 1.8% in the past half-decade. But the IMF, Goldman Sachs and others have come up with “augmented” estimates of nearer to a tenth of GDP, more than five times the official number.
At face value, these estimates imply that China is suffering from a budget gap—not to mention a credibility gap—of Greek proportions. Are things really that bad? Almost certainly not. The augmented figures form a clearer picture of China’s fiscal health. But they also differ from conventional measures in important ways, and so are potentially misleading.
The IMF devised the alternative concept a few years ago, to track the vast amount of spending that occurs off China’s public balance-sheet. Because the central government places tight limits on local-government debts, provinces and cities have long used arm’s length companies, known as local-government financing vehicles (LGFVs), to borrow from banks and issue bonds. That these are really just stand-ins for public borrowing is an open secret. The augmented deficit is a way of making this explicit. Consider the projections for 2016: the government is on course for an official deficit of roughly 3% of GDP. But adding in LGFV borrowing, the IMF forecasts that it will rise to 8.4%.
The augmented estimates also catch other forms of quasi-fiscal spending. Over the past year the authorities have made liberal use of China Development Bank, a “policy bank” specifically charged with supporting government initiatives. Land sales are also an important source of funding. Totting up all the different items, the IMF says China’s augmented deficit will rise to a jaw-dropping 10.1% of GDP in 2016 (see chart). The government is thus giving the economy a fiscal push more than triple the size of its official target.
Although that stimulus may be welcome now, an obvious question is whether public debt is far greater than advertised. Repeated fiscal blow-outs—declared or not—will eventually appear on the balance-sheet. Sure enough, the Chinese government tacitly confirmed the augmented estimates, at least in part, when it added off-balance-sheet debts to its official tally a couple of years ago. Its debt jumped to 38.5% of GDP in 2014 from 15.9% in 2013.
But the augmented deficit is not as frightening as it looks—and certainly not as worrisome as China’s vast corporate debts. First, it does not represent new hidden debt: it is an attempt to assign responsibility, putting the government on the hook for implicit liabilities. Second, spending funded by land sales does not add to debt. Sales must be handled prudently—once an asset is sold, it’s gone—but they are like a development bonus, topping up the coffers so long as urbanisation continues.
Finally, China’s deficit is different from those of developed economies. Outlays on social programmes, though rising, are still low. Much of the deficit stems instead from investment in roads, railways and so forth. “These are not just general spending,” says Helen Qiao, an economist with Bank of America Merrill Lynch. “They generate assets for the government.” So long as the assets are decent, net debt will remain under control, allowing China slowly to rein in its deficits. Indeed, the IMF expects the augmented deficit to average 9% until 2021.
This, however, raises a different concern: that the deficit should in fact be more like those elsewhere.
At around a tenth of GDP, social spending is half of what it is in rich countries. And with China’s population about to age rapidly, the gaps in pension, welfare and health-care systems will soon get much wider without more public money. A strong state backstop would also give people confidence to spend more, supporting the economy’s rebalancing towards consumption. So while China can afford to tame its deficit gradually, it must be quicker to shift its spending habits. More should go on hospitals and pensions, less on power stations.