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19 Mar 2014

Bigger deficit should steady China’s growth

by Qu Hongbin

Chief Economist for Greater China and Co-Head of Asian Economic Research, HSBC

Bigger deficit should steady China’s growth

Tax breaks for small businesses are among the economic reforms planned for 2014

China held its growth target at 7.5 per cent but widened its fiscal deficit forecast to 2.1 per cent of GDP in the budget presented to this year’s National People’s Congress. Premier Li Keqiang confirmed that economic reform is the top priority for 2014. We believe benign inflationary pressures should allow Beijing to stabilise growth while speeding up the changes.

By keeping the GDP growth target unchanged, Beijing is sending a strong signal that it intends to stabilise market expectations and steady the pace of economic growth within a comfortable range

Besides streamlining government, proposed reforms include a deposit insurance scheme, further liberalisation of interest rates, a wider floating band of the renminbi exchange rate, and movement towards capital-account convertibility. There will be new tax breaks for small business and reforms of state-owned enterprises will bring in private capital to areas such as banking, oil, electricity, railway, telecoms, resources development and utilities. Transparency in local government budgets is also promised.

China’s economy grew 7.7 per cent in 2013, just ahead of target, but GDP growth has been about 10 per cent a year for the past decade while the average fiscal deficit was only 1.3 per cent of GDP. The new forecast thus still leaves room for increasing the deficit if needed.

China’s key budget points

  • RMB1.35 trillion budget deficit – 2.1 per cent of GDP
  • Central government spending up 9.3 per cent to RMB7.48 trillion
  • Social welfare expenditure up 9.7 per cent
  • 10 million new jobs and urban unemployment ratio below 4.6 per cent
  • Standardise local government financing
  • Expand local government bonds issuance to RMB400 billion
  • Replace business tax with VAT for telecom services following transport and postal VAT reforms

By keeping the GDP growth target unchanged, Beijing is sending a strong signal that it intends to stabilise market expectations and steady the pace of economic growth within a comfortable range. While a rerun of past stimulus is unlikely, there is flexibility to do this with both monetary and fiscal policy.

Current CPI inflation is well below the 3.5 per cent official target. And although a 2.1 per cent-of-GDP fiscal deficit is more expansionary than last year’s 1.9 per cent, it is still small and can be raised if required. Beijing can ramp up improvements of energy protection, public housing and urban infrastructure – lifting short-term demand and boosting mid and long-term growth sustainability. That can be funded through greater bond issuance and encouraging more private investment.

Some may be disappointed by the unchanged growth target, suggesting a lower priority for reform compared with securing growth. But reform and growth should support each other. Clearly some measures involve short-term pain, but stable economic and labour market conditions are conducive for implementing top-down reforms. If properly implemented, they should boost efficiency and long-term growth prospects.

And within the 7.5 per cent growth target is a subtle change in the mix. Lower trade growth targets imply a greater role for domestic demand while the role of investment will also be gradually reduced. Even within investment, priorities are raising public housing construction to 7 million homes from 6.3 million in 2013, plus agriculture and environmental protection. Meanwhile, increasing social welfare spending and improving employment legislation lean towards greater support for consumption.

The article is from research first published on 5 March, 6 March and 10 March.

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