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Stability is key. That's the message out of China's latest "two sessions" annual meetings. In our view, this makes the return of credit and public investment-driven growth in the next year or two unlikely.
The meetings of the National People's Congress and the Chinese People's Political Consultative Conference set out national policy priorities and ushered in reconstituted state bodies that will lead the country over the next five years.
In this article, we answer key investor questions about what these announcements could mean for China's fiscal and financial metrics.
Frequently Asked Questions
What do the announcements made at the March 2023 China National People's Congress say about the country's economic and financial policy priorities over the next year or so?
The Chinese government has set a target of real GDP growth of around 5%. This summarizes its policy priorities in 2023, in our view. The economic target likely also reflects the weaker global economic conditions this year and the continued headwinds arising from geopolitical factors.
Coming on the back of the relatively weak 3% growth in 2022, this a comfortable target in the eyes of many market commentators. Several forecasters expect the rebound in Chinese demand, following the end of pandemic-related disruptions, to lift real GDP growth above 5% this year.
We believe the 5% target also reflects China's continued focus on longer-term economic and financial stability. Policy support for economic growth this year is unlikely to be so strong that it risks fiscal and financial sustainability. Indicative of this is the government's aim to keep aggregate financing growth in line with nominal GDP growth and its low implied growth for land sales receipts this year.
Consequently, we expect the government to remain wary of sharp rebounds in home prices, real estate developers' leverage ratios, and speculative purchases. This is despite the government's moves to ease credit constraints and home purchase restrictions. We also anticipate Beijing will maintain restrictions on local government off-balance sheet borrowing.
China's GDP growth expectation for 2023 is somewhat below preliminary targets set by most provincial governments. Does this reflect a disconnect between central and regional policy priorities?
The national economic growth target is deliberately low, in our view. A total of 31 Chinese provinces have announced growth objectives for this year. All except four (Beijing, Jiangsu, Qinghai and Tianjin) set their real GDP growth target above the 5% national target announced at the National People's Congress (see chart 1).
The central government seems to be seeking to send a message to agencies and lower-level governments to avoid excessive policy stimulus. Until 2016, for instance, the central government consistently set the national growth target at 7%-8% even though growth in those earlier years typically exceeded these levels.
On the other hand, the 5.5% target in 2022 saw many local governments attempting to offset negative pressures on their economies by ramping up new infrastructure investment, both through their budget and their state-owned enterprises (SOEs).
Provincial governments may have set higher targets to reflect different objectives. In contrast to the national target, the provincial economic targets could track expectations for growth for the year more closely. The intention of the provincial targets is to align investment and spending of various lower-level governments and agencies with expected economic conditions.
If the growth target for this year is lower than in 2022, why is the central government targeting a higher fiscal deficit ratio and larger special-purpose bond issuances?
Despite the larger 2023 national headline budget deficit and special-purpose bond issuance numbers, fiscal support for the economy may not be larger than last year. China's headline budget deficit mainly reflects operating activities under the general budget account, whereas special-purpose bonds are largely for capital activities under separately recorded government-managed fund accounts. Although they are not reflected in the headline deficit numbers, special-purpose bonds add to general government debt.
The headline national budget deficit for this year is Chinese renminbi (RMB) 3.88 trillion or about US$565 billion, compared with RMB3.37 trillion in 2022. The larger fiscal deficit is entirely reflected in the central government accounts. For 2023, the local government operating deficit is budgeted at the same level as in 2022 at RMB720 billion.
Transfers to local governments accounted for about 60% of the increase in the central government deficit. Central government transfers in recent years have helped local governments to record smaller budget deficits (see chart 2).
Rather than reflecting improving budgetary health, the declines likely reflected central government concerns over the rising indebtedness of local governments. Hence, it used transfers to allow weaker governments to stabilize their finances. Apart from maintaining basic social services, it is possible that part of these additional transfers is to help these local governments to narrow their deficit pressures, accordingly alleviating repayment challenges. Other than transfers to local authorities, the increase in central expenditure also reflected higher national security-related spending and interest payments.
The issuance of special-purpose bonds in 2023 may be less than in 2022. The RMB3.8 trillion new issuance quota this year exceeds the RMB3.65 trillion quota announced in the 2022 budget. However, late in 2022, the central government allowed additional new special-purpose bond issuances of about RMB500 billion to help stabilize economic growth. Compared with the total issuance of about RMB4.1 trillion in 2022, the current year new special bond issuance quota is smaller.
The 2022 economic growth rate fell well below the government's 5.5% target. How then did the Chinese government manage to meet its fiscal deficit target for the year?
By cutting spending, selling assets, and increasing transfers from extra-budgetary funds. Extra-budgetary funds comprise mainly capital activities under government managed fund account.
The weak economic situation of last year affected mostly local governments, where 2022 revenue came in about 5.5% below budgetary estimates. Tax revenues bore the brunt of the COVID impact, falling 3.5% compared with growth of 12.2% in 2021. This was partly offset by a 24.4% increase in non-tax revenues as local governments increased tariff rates on local public activities and disposed of various idle assets and resources.
Central government revenue, on the other hand, was in line with budget expectations. Local governments also cut spending by 2.6% relative to the budgeted amount during the year and increased transfers from extra-budgetary funds by 12% relative to the budget.
Taken together, these measures helped to match the declines in both revenue and expenditure to bring the 2022 local government budget deficit to the budget target of RMB720 billion.
How do you expect local governments to perform fiscally over the next two years?
Despite the ongoing economic recovery, we see only a slight narrowing of the budget deficits of most local governments in 2023. There is greater likelihood of a more substantial improvement in 2024, provided the economic recovery is sustained.
Economic uncertainties in 2023 remain significant even though activities are likely to grow more strongly than last year. Consequently, we expect local governments to be wary of unwinding fiscal support for the economy too quickly.
Until economic growth stabilizes, we anticipate tax cuts and public capital spending to be reduced only gradually. Hence, local government budget deficits will remain elevated in many cases and debt positions will continue to worsen (see chart 3).
We project a slow recovery of the property sector to constrain growth of local governments' property-related receipts. Property-related taxes account for about 7% of local governments' total revenues (including both budgetary and extra-budgetary revenues) while land sales account for another quarter.
Despite the importance of these revenue sources, local government finances are not very sensitive to land sale activities. Land projects are mostly self-sufficient in cash flows and local governments are not allowed to finance developments with debt.
Land sales revenues cover most land development costs incurred by most local governments even in the challenging year of 2022, when land sales revenues declined by 22%. However, the property slowdown did depress GDP growth and affect other tax revenue collections (see "China Cities Diverge To Navigate Property Slowdown," published Nov. 1, 2022, on RatingsDirect).
On the other hand, capital spending on projects largely financed by special-purpose bonds will remain as a driving factor for the increase in the local and regional debt burden of local and regional governments over the next two years.
If China's economic recovery falls below expectations, will local governments once again resort to off-balance sheet debts?
It's unlikely. The fiscal capacity of Chinese local governments is capped by the central government's control of their debt quota. Hence, such capacities differ widely across regions (see "The Clock Is Ticking For The Debt-Led Growth Of China Local Governments," published Feb. 21, 2023, on RatingsDirect).
Even in fiscally weak regions, it is unlikely that governments will resume the use of hidden debt financing, e.g. through local government financing vehicles (LGFVs). Following revisions to budget law in 2014, the central government has imposed greater restrictions on local government risk management.
This includes greater scrutiny of SOE management at the local government level, especially LGFVs. Local governments have been charged with monitoring SOEs more closely, especially to keep a close eye on the ability of these companies to make bond repayments. The central government has also curtailed SOEs' more risky borrowings by limiting entities' access to bank loans and new bond issuance.
These efforts have improved the transparency of the operations of these SOEs and reduced their ability to conduct off-balance sheet financing on behalf of their government owners.
The long-term trend is clear: Beijing wants to ease the country off a reliance on investment-driven growth. Officials will grow increasingly tolerant of short-term pain stemming from SOE stress, in our view. The governments are distancing themselves from troubled SOEs (see "China's Local Governments Are Shedding Their Ties To Struggling SOEs," published March 2, 2023). And we believe bondholders may feel the strain.
- China's Local Governments Are Shedding Their Ties To Struggling SOEs, March 2, 2023
- The Clock Is Ticking For The Debt-Led Growth Of China Local Governments, Feb. 21, 2023
- China Cities Diverge To Navigate Property Slowdown, Nov. 1, 2022
Editor: Lex Hall
|Primary Credit Analysts:||Susan Chu, Hong Kong (852) 2912-3055;|
|KimEng Tan, Singapore + 65 6239 6350;|
|Secondary Contact:||Rain Yin, Singapore + (65) 6239 6342;|
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