China’s fiscal policy may be more expansionary than thought last year and expected to ease even further

The general understanding of China’s fiscal stance since the pandemic is that it remained cautious, particularly in 2021. In reality, once the focus is moved from the on-balance sheet measure of China’s fiscal deficit to a broader one including the borrowing by local governments’ financial vehicles (LGFVs), China’s fiscal stance in 2021 was not as tight as generally believed. This is more the case if we consider that growth in 2021 has been much stronger than in 2020 (8.1% versus 2.3%), which should have contributed to a stronger fiscal revenue. 

More specifically, the overall on-balance sheet fiscal deficit (composed of four different accounts, namely the general budget, the government fund, the SOE fund and the social security fund) declined to 4.4% in 2021 from 9.0% in 2020 according to our calculation (Chart 1). The actually realized on-balance sheet deficit was also smaller than the one initially targeted in the government budget (of more than 7%) earlier last year. This is largely due to the rise in fiscal revenue given that GDP growth was higher than the official forecast (8.1% versus above 6%). In fact, nearly all types of government revenue have grown faster than programmed in the initial budget, i.e., actual general budget revenue was 2.5% higher, government fund was 3.7% higher, SOE fund was 34% higher, and social security fund was 6.2% higher.

However, China’s aggregate fiscal balance should also include the off-balance sheet items, in particular LGFVs borrowings. Our estimation shows that the additional fiscal deficit from LGFVs widened to 7.7 percentage points in 2021 from only 3.7 percentage points in 2020, so the aggregate fiscal deficit remained actually rather stable in 2021, with 12.1% in 2021, compared to 12.7% in 2020 (Chart 1). In other words, China’s structural fiscal deficit may have only moderately decreased in 2021.

Stepping into 2022, China’s economic situation has already deteriorated (from 7.9% in Q2 2021 to 4% YoY in Q4 2021), calling for strong fiscal stimulus. To shore up business confidence amid the economic slowdown, the government is aiming at stepping up government-led infrastructure investment. Also, the goal of common prosperity, as well as aging, require stepping up pension and healthcare expenditure.

One caveat for reading this year’s fiscal report is that the government raised additional money, i.e., the surplus profits from designated state-owned financial institutions (including the recent above 1 trillion-yuan profit remittance from the PBoC) and state monopoly business operations, to support fiscal expenditure and stimulate the economy. As booked in fiscal revenue, this part of fiscal support is not consolidated in the current fiscal deficit. Yet, if we consider this amount of support as an external borrowing of the government, the budget plan indicates that China’s on-balance sheet fiscal deficit may further increase to 5.8% of GDP in 2022. Assuming that LGFVs’ borrowing remains constant, the aggregate broadly defined fiscal deficit to increase to 13%. The final fiscal effect could be even higher if the infrastructure spending is pushed even higher with the fiscal resources. The negative impact of the recent omicron wave in China may justify such stronger action on infrastructure spending. On the revenue side, there is limited room for additional tax cuts since China has been lowering its effective tax rate for years (Chart 2).

All in all, the broadly defined fiscal deficit is arranged to grow faster than revenue in 2022 (Chart 3), clearly pointing to bigger fiscal stimulus to ensure a steady economic growth rate. This means that public debt will continue to pile up quickly in 2022.

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