In the first half of 2024, China's GDP grew by 5% year-on-year, with a growth rate of 4.7% in the second quarter. The internal driving force of economic development remains insufficient, and economic growth still heavily relies on policy-driven factors in the short term. At the same time, the complex and volatile external environment persists. To smooth out short-term economic fluctuations and stimulate effective demand, moderately increasing the fiscal deficit ratio in a timely manner is a relatively prudent and effective policy tool. The national fiscal budget deficit for 2023 was set at 3%, and in October 2023, the budget was adjusted to increase the deficit by 1 trillion yuan, resulting in a final fiscal deficit ratio of 3.8%. In 2024, China's budget deficit ratio continues to be set at 3%, with the quota for local government special bonds arranged at 3.9 trillion yuan, slightly increased from last year, but still insufficient. Faced with the current deep adjustment of the real estate market, the decline in comprehensive financial strength of local governments, and sluggish consumer spending, a more proactive fiscal policy is imperative. Drawing on relevant international experiences, stimulating effective demand and preventing the economy from falling into a negative cycle of balance sheet recession, fiscal policy will play a more important and prominent role in the next phase.
I. Increasing the Fiscal Deficit Ratio in the New Era is Necessary
The real estate force that has driven China's economic growth in the past is weakening. Based on changes in population structure (main home-buying population), urbanization process, and the space for improved demand, we estimate the trend of rigid demand for urban residents in China in the next phase. According to our calculations, 2019-2021 will be the peak of rigid demand for urban residents in China in the past 20 years. With changes in population structure, the decline of the main home-buying age group, the gradual flattening trend of urbanization process, and the marginal decrease in the area of rigid demand improvement for urban residents, we predict that the trend of rigid demand for real estate among urban residents in China will gradually weaken. The medium and long-term changes in the rigid demand for real estate among urban residents in China have a significant impact on China's economy and will also have an important impact on China's economic structure.
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In the next phase, an additional sales area of 900 million square meters per year may be the desirable level to meet the rigid demand for improved demand in China. Considering that the excess demand from 2015 to 2021 was 100-200 million square meters per year, the actual sales area in the next phase may be less than 900 million square meters. Specifically, due to the low levels of real estate new starts and land purchases in 2022-2023, if the current policy intensity is maintained, our leading indicators show that the growth rate of real estate development investment in 2024 may still be around -10%.
Considering the impact of current policies on the effects of real estate "inventory collection," according to our calculations, if it is only to bring the inventory of unsold commercial housing that has been constructed back to a normal level, the scale of inventory collection funds needed is approximately 1.12 trillion yuan. Furthermore, to achieve the normalization goal of housing inventory in the real estate market that has not been constructed and the long-term vacant second-hand housing inventory, an additional inventory collection fund scale of approximately 4.58 trillion yuan is needed. Even with such a large-scale "inventory collection" policy, the real estate market can only return to a path of stable development and cannot serve as an important force to drive economic growth as it did in the past.
The local government debt-driven model that has driven China's economic growth is weakening. Due to the lack of relevant fiscal statistical data, it is very difficult to directly calculate the full-scale local government fiscal deficit. The International Monetary Fund (IMF Working Paper: Fiscal Vulnerabilities and Risks from Local Government Finance in China) has attempted to estimate the scale of China's broad fiscal deficit.
By classifying the sources of fixed asset investment funds, we exclude the part paid by national budget funds from the infrastructure expenditure data we have calculated, thus initially obtaining the local budget-outside infrastructure expenditure data.
By connecting infrastructure expenditure and infrastructure revenue data with budgetary fiscal data, a rough outline of the broad fiscal deficit scale can be obtained and monitored in real-time.
Of course, there are many shortcomings in our calculation method, such as a strong assumption about budget-outside fiscal expenditures. For example, we may underestimate the participation of the private sector in infrastructure construction.
Assumption 1: Before 2008, the scale of local government debt (including local government financing platforms, etc.) was not large, and this calculation basically ignores it. The local debt issue became a new problem after the "four trillion" investment opportunity in 2009, and it was not significant before 2008. According to the research by Li Yang and others (2012), the scale of local government debt before 2008 was very small, and it can be ignored in our calculation here.Assumption 2: Due to issues with data availability, we only consider the repayment of local financing platform bonds when calculating the annual repayment of local government debt. This part is obtained by summing up the maturity repayment amounts of local financing platform debts in various provinces. Considering that the main body of local debt is the local financing platform, Assumption 2 is reasonable.
In summary, according to our rough estimates, by summing up the net general fiscal deficits calculated from 2009 to 2023, the current total scale of local government debt has reached 98 trillion yuan, accounting for about 78% of China's nominal GDP in 2023. Of course, due to the lack of data, our estimation process contains many estimated components and assumptions, and there are many discrepancies with the actual situation. However, the further expansion of local government debt will have an impact on China's financial stability and healthy economic development. The local government debt-driven model has gradually declined after playing its role in a specific historical period.
The return on investment in China's real economy continues to decrease, requiring fiscal policy to play a structural role. The return on investment in China's real economy has been continuously declining since 2008, and it has dropped to the risk-free financing cost of the financial market around 2014. This means that excessive liquidity is unwilling to enter the real economy and is more willing to circulate among various assets, forming local bubbles and threatening economic and financial stability. When the return on investment in the real economy drops to the risk-free return rate of the financial market, the returns generated by financing are not enough to cover the financing costs, which is the root of some financial risks. According to our model decomposition, changes in government scale and population structure are the main factors affecting the decline in the return on investment in China's real economy after 2008. The faster the population structure tends towards aging, the greater the drag on the return on investment in the real economy of the whole society. Historically, improving the return on investment in the real economy mainly depends on further expanding the reform dividends of the industry, population and other resource endowments, and capital deepening. The release of reform dividends in the industry is not a one-day task; strengthening population policy and education and training relies on enhancing population resource endowments; capital deepening depends on continuous capital investment in medium and high-end manufacturing industries.
At the current stage, fiscal policy has a lot to do, and it is necessary to moderately increase the deficit ratio. First, the continuous low return on investment in the real economy may lead to insufficient effective investment demand, and even a "liquidity trap." A large amount of funds are deposited in banks, leading to limited expansion effects of monetary policy, so fiscal policy should be more active. Fiscal policy is more flexible and effective than monetary policy in structural tools, and it has the ability to implement more active fiscal policies with targeted measures to promote investment in areas such as technology and high-end manufacturing that can improve the return on investment in the real economy.
Second, in the past, the relationship between local comprehensive financial strength and the real estate market was relatively close, mainly affecting the comprehensive financial strength of local governments positively through land transfer fees and other means (Wang Dehua, 2023). At present, the real estate market is weak, land transfer income has plummeted, and local financial operations are relatively difficult. Moderately increasing the deficit ratio level helps to improve the actual ability of local governments to operate financially and alleviate financial problems caused by the weak real estate market. At the same time, increasing the fiscal deficit ratio helps to increase regular project expenditures, focusing on supporting grassroots government transfer payments, alleviating grassroots financial difficulties, and resolutely investigating arbitrary fees and fines. The increased fiscal expenditure can be used to subsidize small and micro enterprises for rent and utility bills, as well as providing cash subsidies to general困难 families.
Third, moderately increasing the fiscal deficit ratio can more effectively and transparently improve the implementation ability of a series of important policies after local governments strictly control their debt scale. Special treasury bond projects should ensure interest payments and principal repayments upon maturity, which is not as transparent as directly increasing the fiscal deficit. If the fiscal deficit is directly increased, the budget will be more transparent and easier to accept supervision and standardization.
Of course, the current fiscal system urgently needs reform, including the division of financial powers between central and local governments, transfer payment issues, and the improvement of local main tax types. Moderately increasing the fiscal deficit ratio will be a powerful tool for effectively and transparently improving the return on investment in the real economy and the financial strength in the new era during this stage.
II. The traditional fiscal deficit ratio standard is not scientific
In the discussion of fiscal deficit ratios and government debt, the deficit ratio of 3% and debt ratio of 60% stipulated by the Maastricht Treaty (hereinafter referred to as the "Maastricht Treaty") formulated by Europe in 1992 are often used as reference standards. They are cited as the so-called "international safety line" or "international warning line" to judge the financial situation of countries, and actual work is also influenced to a certain extent by this standard, but this standard is not scientific and does not keep pace with the times.
First, the formulation of the Maastricht Treaty standard has the limitations of the times. The discussion on fiscal deficits and national debt is only a threshold condition for joining the EU, not a so-called standard. Why is it 3% and 60% instead of others? From the information currently available, the EU did not provide an accurate calculation basis at the time. The reference value did not appear in the main text of the Maastricht Treaty but was given in an annex agreement, without any related explanation, which has the limitations of the times.Second, to maintain the controllable fiscal risks in the medium and long term, and to keep the debt ratio stable, the current deficit ratio should try not to exceed the product of the government debt ratio and the economic growth rate, rather than rigidly adhering to the red line of a 3% deficit ratio. The fiscal security of an economy will not fall into difficulty due to an increase in the short-term deficit ratio, mainly depending on the medium and long-term relationship between the deficit ratio, economic growth rate, and debt ratio. Currently, raising the deficit ratio and breaking through the so-called standard of 3% does not mean that it will affect the issue of fiscal sustainability. The key is whether the increase in the deficit ratio can raise the central point of economic growth.
Third, the reference standards of the Maastricht Treaty have been broken through by many developed economies and emerging market economies at the current stage, and there is no obvious fiscal risk. Against the background of economic recession or slowdown in various countries, promoting economic recovery as soon as possible is the top priority. Fiscal risk control emphasizes medium and long-term dynamic balance, emphasizes short-term stability and the improvement of the medium and long-term growth center, and cannot be too concerned about temporary gains and losses.
In summary, the traditional fiscal deficit standards are not scientific, and the theoretical and empirical foundations for their formulation are not solid, and the fiscal risk control in practice is not significant, and the actual implementation is not satisfactory. At a new stage, our country should break free from the shackles of traditional fiscal deficit standards, expand fiscal deficits more creatively and moderately, and take a long-term balanced path of fiscal deficits with Chinese characteristics.
III. The direction of fiscal deficit investment and cooperation with the central bank
Moderately and timely increase the fiscal deficit ratio to deal with economic growth and development issues. Based on a comprehensive examination of promoting resident consumption, stabilizing the real estate market, and the comprehensive financial strength of local governments, we suggest moderately increasing the fiscal deficit ratio by about three percentage points. According to this year's expected GDP scale, the deficit should increase by 4-5 trillion yuan, mainly in the form of increasing central fiscal deficits. The short-term increase in fiscal deficits is mainly to deal with the problem of insufficient effective demand in the process of economic development. At present, resident consumption is weak, manufacturing investment is slow, and a series of chain reactions caused by real estate investment have emerged, and the financial problems of local governments need to be alleviated urgently.
Increasing the fiscal deficit ratio is more direct, effective, and transparent. Directly increasing the fiscal deficit ratio has a more direct and extensive scope of application. It can be used to make up for the shortcomings of people's livelihood expenditures, can be used for expenditures in key construction areas, and can also increase the targeting of transfer payments to alleviate local financial pressure. Increasing fiscal deficits are more flexible and effective than current special treasury bonds and special bonds, most of which follow a project system and require a lot of approval processes. Directly increasing fiscal policy is more flexible and applicable to the rapid deployment of fiscal policy under new circumstances. Increasing the fiscal deficit ratio is more transparent and conducive to supervision than other forms of debt financing, effectively preventing the misallocation and misappropriation of fiscal funds.
According to our calculations, it is more appropriate to increase the fiscal deficit ratio by about three percentage points. On the one hand, the current problem of insufficient effective demand should be avoided from falling into a negative cycle in time, and the intensity of fiscal policy should be moderately increased. Adding three percentage points of fiscal deficit is more reasonable. One percentage point is used to subsidize the effective demand gap of insufficient resident consumption, one percentage point is used to repay the historical arrears owed to some private enterprises by local governments and to ensure the normal operation of grassroots administrative functions, and one percentage point is used to promote the construction of science and technology, high-end manufacturing, and other areas. The structural role of the newly added fiscal deficit plays an immeasurable role in ensuring people's livelihoods and improving China's scientific and security capabilities in key areas. On the other hand, the domestic and foreign environment and the economic growth of major developed economies have a risk of recession in the next stage. We should be prepared for the future, focus on domestic demand, take the lead, and prepare effective prevention and policy reserves in advance.
The direction of fiscal deficit investment is mainly people's livelihood and key construction areas. We suggest that the newly added fiscal deficit can provide phased direct subsidies to low and middle-income families to promote consumption. At present, the "Golden Tax Phase IV" has been launched and can clearly understand the income situation of each family. Central fiscal subsidy funds can be directly piloted. Part of the newly added fiscal deficit can be transferred to localities to alleviate local financial difficulties and resolutely curb local excessive taxes and arbitrary fees. Government investment projects owe money to enterprises, which is one of the reasons for the lack of confidence in enterprises. The income from general debt financing can be used to repay the arrears owed to enterprises, combined with resolutely curbing local excessive taxes and arbitrary fees, which can boost enterprise confidence and promote effective private investment. At the same time, the implementation of national major strategies and the construction of key areas' security capabilities ("two heavy") are important guarantees for promoting Chinese-style modernization. The "two heavy" construction focuses on promoting Chinese-style modernization, focusing on key tasks such as accelerating the realization of high-level scientific and technological self-reliance, promoting the integrated development of urban and rural areas, promoting coordinated regional development, improving the security guarantee capacity of food, energy, and resource security, promoting high-quality population development, and comprehensively promoting the construction of a beautiful China, providing important guarantees for promoting Chinese-style modernization. The direction of the newly added fiscal deficit will also be biased towards "two heavy" construction that conforms to the medium and long-term development strategy.
Moderately increase the fiscal deficit ratio and actively cooperate with the central bank to improve the macro-governance system. "As the economy shifts from high-speed growth to high-quality development, monetary credit needs to shift from extensive expansion to intensive development, maintaining a reasonable abundance in total and increasing and decreasing in structure." The central credit expansion on the fiscal side and the total amount on the monetary side means that fiscal and monetary need to strengthen cooperation to achieve long-term goals in the process of economic transformation. After moderately increasing the fiscal deficit ratio and issuing more national bonds, when the proportion of national bond stocks rises sharply, national bonds need to become one of the important tools for the central bank to adjust liquidity and support the development of the real economy. Compared with international comparisons, in 2022, the proportion of U.S. national bonds to GDP was 110.2%, Japan was 214.3%, and China was 23.6% in 2023, which was significantly lower. However, in the future, with the continuous issuance of ultra-long-term special national bonds, the importance of national bonds as a central bank operation tool will be greatly enhanced. The "People's Bank of China Law" prohibits the central bank from subscribing to national bonds in the primary market but can buy and sell in the secondary market, including repurchase transactions and outright transactions, etc. After moderately increasing the fiscal deficit ratio and issuing more national bonds, we expect the central bank to continue to actively cooperate, mainly using secondary market conventional tools, and gradually explore new ways of fiscal and central bank cooperation to improve the macro-governance system.
IV. Concerns about increasing the fiscal deficit ratioWill increasing the fiscal deficit ratio significantly affect China's inflation center? Raising the fiscal deficit ratio, with the central bank cooperating to expand the scale of government bonds, will not lead to a significant increase in China's inflation center. Whether active fiscal policy and loose monetary policy will bring inflation depends on the overall production supply capacity of the economy. We divide the economy's production supply into two sectors: low production efficiency sectors and high production efficiency sectors. From the perspective of the quantity equation of money, classical theory believes that loose fiscal and monetary policies have no significant impact on production, so the increase in money supply is mainly reflected in the rise of prices, that is, inflation. In fact, loose monetary policy has an impact on production, and the impact varies across industries.
Low production efficiency sectors (such as sectors with low capital deepening) face weak supply capacity when facing fiscal and monetary easing, and cannot quickly expand supply in a low-interest-rate environment, so loose fiscal and monetary policies are easily reflected in the rise of product prices. High production efficiency sectors (such as sectors with high capital deepening) face strong supply capacity when facing fiscal and monetary easing, and can quickly expand supply in a low-interest-rate environment, so loose fiscal and monetary policies are not reflected in the rise of product prices. When supply increases rapidly, loose fiscal and monetary policies stimulate supply, which may be reflected in a decrease in product prices, that is, loose fiscal and monetary policies coexist with deflation in some industries.
The production efficiency of low-efficiency sectors is weak, and loose fiscal and monetary policies are difficult to increase supply output; the production efficiency of high-efficiency sectors is strong, and loose fiscal and monetary policies are easy to increase supply output. So, why do loose fiscal and monetary policies have different reactions in different economies? The main reason is that the proportion of low production efficiency sectors and high production efficiency sectors in each economy is different. For example, when the proportion of high-end manufacturing (high capital deepening, similar to high production efficiency sectors) in an economy reaches a certain threshold, loose fiscal and monetary policies are reflected in the inflation of products in low production efficiency sectors, but deflation in high production efficiency sectors. When the proportion of high production efficiency sectors in an economy exceeds the threshold (this threshold can be obtained through international comparison and historical data to get a rough empirical value), then loose fiscal and monetary policies may not bring a high overall inflation level, such as China with strong manufacturing and a wide range of industrial sectors, and future Vietnam. On the contrary, economies dominated by low production efficiency sectors are likely to bring inflation due to loose fiscal and monetary policies, such as some economies in South America.
Will increasing the fiscal deficit ratio affect China's medium and long-term fiscal security? Will the short-term increase in the fiscal deficit ratio affect China's fiscal security in the medium and long term, and will it cause concerns about China's government debt level? According to our calculation of the comprehensive dynamic equation of government debt ratio, if the medium and long-term real economy investment return rate is greater than the debt financing cost, that is, the government's debt ratio will converge to a constant. In economic terms, that is, if the return rate of local government department debt financing investment projects continues to be higher than their financing costs, then the continuously obtained investment returns will be used to repay the principal and interest, and the debt financing pressure in the next period may be reduced, and the local government debt leverage ratio will eventually converge to a constant. Therefore, whether the return rate of fiscal investment projects of local government departments in China is higher than the financing cost is the key to whether its leverage ratio can be stable and reduced. If the real economy investment return rate is lower than its debt financing cost, then the leverage ratio of local government debt financing, from the form of the model, will not have a steady-state solution, that is, the local government's debt leverage ratio will not converge, continue to climb to new highs, and thus cause fiscal risks. In economic terms, that is, if the return rate of local government department debt financing investment projects continues to be lower than their financing costs, then the continuously obtained investment returns will not be enough to repay the principal and interest, and the debt financing pressure in the next period may be increased, and the local government debt leverage ratio will continue to rise. In summary, whether increasing the fiscal deficit ratio will affect China's medium and long-term fiscal security depends on whether the additional fiscal deficit can play a structural role, further promote the improvement of real economy investment return rate, and whether it can stabilize and improve China's medium and long-term economic growth center level.
Overall, we suggest that the fiscal deficit ratio should be increased in a timely and moderate manner, breaking through the outdated framework of traditional fiscal deficit ratios. In the case of insufficient effective demand in real estate, local government comprehensive financial strength, resident consumption, and manufacturing investment, increasing the fiscal deficit by about three percentage points can effectively support current economic growth, alleviate the problem of insufficient local comprehensive financial strength, support people's livelihood, and play an important role in improving the expectations of private capital. In the medium and long term, there is no need to worry too much about the inflation center rise and medium and long-term fiscal and debt risks caused by expansionary fiscal and monetary policies. Actively play the structural role of finance, and ensure that China's economy can go far. The basic situation of China's development has not changed. From the comprehensive consideration of the development stage, development conditions, and development advantages, China's development prospects are still optimistic in the long term. We must unswervingly deepen reform, expand opening up, pay more attention to the effective implementation of macro policy regulation, and promote high-quality economic development, while maintaining a reasonable economic growth rate. I believe that China's economy can go far, and take the path of high-quality development with Chinese characteristics.