China Em­brac­ing Ex­pan­sion­ary Fis­cal Pol­icy

China's Foreign Trade (English) - - Contents - By Betty Rui Wang, Shuang Ding

Since the 1994 fis­cal re­form, China’s of­fi­cial bud­get has been con­ser­va­tive, with the deficit never reach­ing 3% of GDP. Re­cently, how­ever, pol­icy mak­ers have called for a review of the im­plicit 3% limit. The 2016 bud­get pro­posal con­firms the au­thor­i­ties’ readi­ness to adopt more ex­pan­sion­ary fis­cal pol­icy to achieve the GDP growth tar­get of above 6.5% un­der the 13th Five Year Plan (FYP, 2016-20).

The larger pro­jected deficit is due mainly to stag­nat­ing rev­enues and tax cuts. Rev­enues missed the tar­get in 2015 on slower growth and PPI de­fla­tion. In ad­di­tion, the value-added tax ( VAT) will be ex­panded to the whole ser­vices in­dus­try (re­plac­ing the busi­ness tax) from May 1, ef­fec­tively re­duc­ing the cor­po­rate tax bur­den. Some ad­min­is­tra­tive fees im­posed on en­ter­prises will also be re­moved. Our es­ti­mates of the gen­eral pub­lic bud­get and the gov­ern­ment funds bud­get show zero growth in rev­enues and about 2% growth in ex­pen­di­ture in 2016 rel­a­tive to 2015.

Our es­ti­mate, based on widely ac­cepted ac­count­ing meth­ods, points to a wider bud­get deficit of 3.8% of GDP, versus the head­line 3%. Our es­ti­mate amounts to CNY 2.776tn, CNY 596bn higher than the of­fi­cial num­ber. We think the deficit will be fi­nanced by cen­tral gov­ern­ment bonds (CNY 1.4tn), lo­cal gov­ern­ment gen­eral bonds (CNY 780bn), lo­cal gov­ern­ment spe­cial bonds (CNY 400bn, for lo­cal projects) and gov­ern­ment de­posits (CNY 196bn). We also ex­pect the lo­cal gov­ern­ments to is­sue CNY 5tn of bonds to re­place ma­tur­ing loans.

Tem­po­rar­ily in­creas­ing the fis­cal deficit

China looks set to adopt a more proac­tive fis­cal stance and tem­po­rar­ily em­brace a higher fis­cal deficit in the com­ing years. First, the above- 6.5% GDP growth tar­get for the next five years re­quires fur­ther pol­icy sup­port. We es­ti­mate China’s self- sus­tain­ing growth rate at 6% (at best); in our view, the gov­ern­ment will need more pol­icy stim­u­lus to achieve this. Sec­ond, China still has fis­cal room to sup­port growth. The coun­try’s pub­lic debt re­mains man­age­able rel­a­tive to its peers. We es­ti­mate that to­tal gov­ern­ment debt was 60-70% of GDP (matched by a large amount of state as­sets) in 2015, in­clud­ing lo­cal gov­ern­ments’ con­tin­gent debt. Third, pol­icy mak­ers ap­pear to favour fis­cal pol­icy over mon­e­tary pol­icy as the main tool to boost the econ­omy given con­cerns about the neg­a­tive im­pact of China’s ul­tra-loose mon­e­tary pol­icy and al­ready-high pri­vate-sec­tor lever­age.

• CHINA’S 2016 BUD­GET DEFICIT TAR­GET OF 3% OF GDP CON­FIRMS EX­PAN­SION­ARY FIS­CAL STANCE; WE ES­TI­MATE 3.8%

• TAX CUTS, IN­STEAD OF SPEND­ING STIM­U­LUS, ARE THE MA­JOR REA­SON FOR THE LARGER DEFICIT

• THE EN­LARGED DEFICIT WILL BE FI­NANCED BY BOND IS­SUANCE AND GOV­ERN­MENT DE­POSITS

The 2016 bud­get Us­ing broadly ac­cepted ac­count­ing stan­dards, China’s 2016 bud­get deficit will be as high as 3.8% of GDP, or CNY 2.776tn. This is CNY 596bn larger than the of­fi­cial deficit of CNY 2.18tn and the 2015 fi­nal deficit of CNY 2.36bn.

• Gen­eral pub­lic bud­get. Un­like the of­fi­cial (and out­dated, in our view) cal­cu­la­tion of the bud­get, we treat withdrawals from fis­cal sta­bil­i­sa­tion funds and the use of left­over funds from pre­vi­ous years as fi­nanc­ing of the deficit, in­stead of rev­enue. Our deficit es­ti­mate un­der this cat­e­gory is there­fore CNY 170.5bn higher than the of­fi­cial num­ber.

• Govern­men­talso deficit,on the think which gen­er­althe funds is of­fi­cial cal­cu­lat­ed­pub­lic bud­get. bud­get, bud­get basedWe does f is­cal not con­di­tions­fully ref for lect 2016, ac­tu­alas the gov­ern­ment funds bud­get is run­ning a deficit this year rather than be­ing in bal­ance. Land-sale rev­enues, which ac­count for more than 80% of the rev­enues of lo­cal gov­ern­ment funds, are ex­pected to con­tract 13.2% y/y in 2016. In ad­di­tion to fis­cal trans­fers from the cen­tral gov­ern­ment (down 11.9%), we think spe­cial bond is­suance of CNY 400bn and car­ry­over funds (CNY 25bn) will be used to fi­nance the gap be­tween rev­enue and ex­pen­di­ture.

We ex­pect broader fis­cal pol­icy to have a larger im­pact on the econ­omy in 2016 for two rea­sons: 1. 2015 ex­tra­bud­getary ac­tiv­ity con­tracted due to tighter con­trols on lo­cal gov­ern­ment debt; we do not ex­pect a fur­ther con­trac­tion in 2016; and 2. the 2015 ac­tual fis­cal deficit was much higher than bud­geted as lo­cal gov­ern­ments started to use their ac­cu­mu­lated fis­cal de­posits ( CNY 706bn) to fi­nance ad­di­tional ex­pen­di­ture. There is room to draw down those de­posits fur­ther if nec­es­sary.

Stag­nant rev­enue growth

Slow eco­nomic growth and tax cuts are the ma­jor cul­prits

We think China’s fis­cal rev­enue is un­likely to achieve dou­ble-digit growth in the near fu­ture — an in­evitable re­sult of the eco­nomic slow­down. The high cor­re­la­tion be­tween China’s nom­i­nal GDP growth and pub­lic rev­enue growth in the past two decades sug­gests that growth in pub­lic rev­enue will trend lower amid China’s eco­nomic tran­si­tion and slow­down. The con­tin­u­ous de­cline in pro­ducer prices is ag­gra­vat­ing the down­ward pres­sure on fis­cal rev­enue.

Struc­tural tax re­duc­tion and fee re­duc­tion

Struc­tural ta x cuts and fee re­duc­tions, an im­por­tant area of sup­ply­side re­forms, are an im­por­tant rea­son be­hind stag­nant rev­enue growth. Fi­nance Min­is­ter Lou Ji­wei has estimated a to­tal of CNY 500bn (3% of pub­lic rev­enue) of tax and fee re­duc­tions in 2016, up from CNY 300bn in 2015. Tax re­duc­tions were ini­tially in­tro­duced to re­duce the tax bur­den on small and mi­cro en­ter­prises. High­tech and high-value-added com­pa­nies, and even some in­di­vid­u­als, could now ben­e­fit. Struc­tural tax re­form is an­other im­por­tant as­pect of struc­tural tax re­duc­tion and will have a more far­reach­ing im­pact on the fis­cal regime, eco­nomic struc­ture and growth out­look.

Us­ing broadly ac­cepted ac­count­ing stan­dards, China’s 2016 bud­get deficit will be as high as 3.8% of GDP, or CNY 2.776tn.

Lou’s fis­cal work re­port pre­sented at the NPC this year listed the fol­low­ing as struc­tural tax re­form pri­or­i­ties for 2016: com­plet­ing the tran­si­tion from the busi­ness tax to VAT; in­di­vid­ual in­come tax (IIT) re­form; do­mes­tic con­sump­tion tax; and en­vi­ron­men­tal tax re­forms.

Tran­si­tion­ing from busi­ness tax to VAT: VAT is the big­gest tax item, con­tribut­ing 24.9% of tax rev­enue in 2015. The current stan­dard man­u­fac­tur­ing tax rate is 17%. The busi­ness tax, which ac­counts for 15.5% of to­tal tax rev­enue, is mainly levied on ser­vices sec­tors; most sec­tors are sub­ject to tax rates of 3% or 5%. The tran­si­tion of the busi­ness tax to VAT, which started in 2011, has been achieved mainly by re­duc­ing VAT rates (to 11%, 6% and 3% from the stan­dard 17%) and in­clud­ing more de­ductible as­sets (even prop­erty, start­ing this year) to avoid du­pli­cate tax­a­tion, re­duce the tax bur­den on cor­po­rates, and ad­just the eco­nomic struc­ture. Re­forms have pro­gressed in the past four years, but faced de­lays in 2015 amid slug­gish do­mes­tic growth. 2016 will be the fi­nal year of this re­form, with VAT cov­er­age ex­tend­ing to the con­struc­tion, realestate, fi­nan­cial and con­sumer ser­vices sec­tors — the fi­nal four, but most com­plex, ser­vices sec­tors.

In­di­vid­ual in­come tax re­form: IIT ac­counts for only 7% of to­tal tax rev­enue and has a lim­ited role in in­come re­dis­tri­bu­tion ef­fects. The last time China re­formed the IIT was to in­crease the monthly tax de­duc­tion to CNY 3,500 in 2011, from CNY 2,000. Lou in­di­cated that IIT re­form is not sim­ply about in­creas­ing tax de­duc­tions, how­ever. China’s IIT has wide tax brack­ets and is not house­hold-based, in con­trast to OECD coun­tries. The re­form ap­proach now un­der dis­cus­sion is to in­clude a wider range of in­come as tax­able in­come to strengthen re­dis­tri­bu­tion ef­fects; in­tro­duce var­i­ous tax de­duc­tions or cred­its; and con­sider in­tro­duc­ing joint tax fil­ing for mar­ried cou­ples. Given the com­plex­ity of the is­sue, this is likely to be a grad­ual process.

Do­mes­tic con­sump­tion tax: this tax dif­fers from the com­mon con­cept of con­sump­tion tax in other coun­tries, which is equiv­a­lent to VAT. In China, this tax is levied on spe­cific items, in­clud­ing lux­ury goods, al­co­hol and cig­a­rettes. The fu­ture re­form di­rec­tion is to in­clude re­fined oil and high- en­ergy- con­sum­ing prod­ucts to im­prove fis­cal rev­enue and dis­cour­age con­sump­tion detri­men­tal to health and the en­vi­ron­ment. The tax rate is also likely to be ad­justed.

En­vi­ron­men­tal tax: this has been high­lighted as a re­form area for 2016, in co­or­di­na­tion with the re­vi­sion of the en­vi­ron­men­tal pro­tec­tion law. Re­form­ing the en­vi­ron­men­tal tax and fees is aimed at pro­mot­ing more en­vi­ron­men­tally friendly growth.

Prop­erty tax: in­tro­duc­ing a prop­erty tax has been dis­cussed for many years in China. While this is not listed as a re­form priority in 2016, a leg­isla­tive plan is un­der dis­cus­sion.

China has nu­mer­ous trans­ac­tion-based taxes and fees on land and prop­erty, in­clud­ing the prop­erty tax, fees for us­ing state land, an ur­ban land use tax, a land ap­pre­ci­a­tion tax, and a tax on deeds. Most are levied by lo­cal gov­ern­ments and they ac­count for 16% of lo­cal tax rev­enue. How­ever, a re­cur­rent prop­erty tax is needed, as it has a more sta­ble tax base. Pi­lot cities in­clud­ing Shang­hai and Chongqing im­ple­mented a re­cur­rent prop­erty tax in 2011. Na­tion­wide, realestate reg­is­tra­tion rules took ef­fect in March 2015. Ex­pand­ing the re­cur­rent prop­erty tax na­tion­wide is likely to bet­ter align lo­cal gov­ern­ments’ rev­enue with their spend­ing obli­ga­tions, con­tain spec­u­la­tion, and fa­cil­i­tate ur­ban de­vel­op­ment. The IMF es­ti­mates that the ini­tial con­sol­i­da­tion of current trans­ac­tion-based taxes and fees on prop­erty into a re­cur­rent prop­erty tax could be rev­enue neu­tral. Over time, eco­nomic growth and ur­ban­i­sa­tion could gen­er­ate more lo­cal rev­enue, strengthen the fis­cal po­si­tion and op­ti­mise re­source al­lo­ca­tion.

The re­align­ment of fis­cal rev­enue with spend­ing obli­ga­tions be­tween the cen­tral and lo­cal gov­ern­ments is an­other fo­cus area of tax re­form. Re­forms in this area have been slower than ex­pected, ac­cord­ing to Lou. Lo­cal gov­ern­ments’ spend­ing re­spon­si­bil­i­ties go be­yond their bud­gets for his­tor­i­cal rea­sons. Struc­tura l ta x re­form could also po­ten­tially re­duce lo­cal gov­ern­ments’ rev­enue. Tak­ing VAT re­form as an ex­am­ple, tax rev­enue from VAT is cur­rently shared be­tween the cen­tral (75%) and lo­cal gov­ern­ments (25%). The busi­ness tax, how­ever, is a lo­cal tax and is the big­gest con­trib­u­tor to lo­cal gov­ern­ments’ tax rev­enue. Dur­ing the tran­si­tion pe­riod, VAT rev­enue col­lected from ser­vices sec­tors still goes en­tirely to lo­cal gov­ern­ments rather than be­ing shared with the cen­tral gov­ern­ment. How­ever, if the re­form is com­pleted, tax rev­enue will be re­al­lo­cated. Ac­cord­ing to Lou, guid­ance on how to re­align spend­ing obli­ga­tions be­tween the cen­tral and lo­cal gov­ern­ments will be an­nounced this year, and a tran­si­tional plan on how to share VAT rev­enue be­tween the cen­tral and lo­cal gov­ern­ments will be rolled out at some point in the fu­ture.

Op­ti­mis­ing the fis­cal spend­ing struc­ture

This year’s larger fis­cal deficit harkens back to 2008-2009, when China rolled out a mas­sive fis­cal stim­u­lus pack­age, and has led in­vestors to ask whether his­tory might re­peat it­self. The 2016 bud­get sug­gests that spend­ing growth will be mod­est, how­ever.

Gen­eral pub­lic bud­get spend­ing (af­ter ad­just­ment) is set to grow 6.7% in 2016, much slower than nom­i­nal GDP growth. Gov­ern­ment funds spend­ing is bud­geted to fall by 1.2%. Com­bined spend­ing will grow only 1.8%, ac­cord­ing to our cal­cu­la­tion. The fo­cus in 2016 will be on op­ti­mis­ing the spend­ing struc­ture rather than ag­gres­sively in­creas­ing spend­ing in spe­cific sec­tors (as in 2008-2009).

Strict con­trols on spend­ing on of­fi­cials’ over­seas travel, busi­ness cars and busi­ness re­cep­tions will re­main in place, while spend­ing on so­cial wel­fare and nec­es­sary pub­lic ser­vices is se­cured. Ed­u­ca­tion, tech­nol­ogy, so­cial se­cu­rity and health care have been high­lighted as key sec­tors to re­ceive fis­cal sup­port in 2016. This is dif­fer­ent from the 20082009 fis­cal stim­u­lus, which fo­cused heav­ily on in­vest­ment in in­fra­struc­ture and trans­port con­struc­tion.

Fi­nanc­ing the deficit

The gov­ern­ment will also use a va­ri­ety of chan­nels to fi­nance spend­ing. The use of sta­bil­i­sa­tion funds is one tra­di­tional way to top up. Con­sol­i­dat­ing and util­is­ing car­ry­over and left­over funds is also an im­por­tant way to fund spend­ing. In 2015, a to­tal of CNY 706bn of left­over funds (4.7% of lo­cal gov­ern­ments’ ex­pen­di­ture) were used to off­set the gap be­tween rev­enue (un­der­shoot­ing the bud­get) and spend­ing (over­shoot­ing the bud­get). In ad­di­tion, the gov­ern­ment is ex­plor­ing ways to make gov­ern­ment spend­ing and in­vest­ment more ef­fi­cient. Rather than be­ing fully in­vested, fis­cal money can be in­vested in in­dus­trial funds and eq­ui­ties; the gov­ern­ment can also at­tract pri­vate cap­i­tal in the form of PPP projects; fis­cal sub­si­dies are an­other in­di­rect way to sup­port in­vest­ment. This is dif­fer­ent from 2008-2009, when lo­cal gov­ern­ments’ ex­tra-bud­getary fi­nanc­ing and the rapid ex­pan­sion of lo­cal gov­ern­ment fi­nanc­ing ve­hi­cles ( LGFVS) were the main chan­nels to fi­nance gov­ern­ment-backed in­vest­ment projects.

Lo­cal gov­ern­ment debt swap likely to ex­pand in 2016

The lo­cal gov­ern­ment debt ceil­ing is set at CNY 17.18tn for 2016, CNY 1.18tn higher than in 2015. 2015 was the first year of lo­cal gov­ern­ment debt re­form — ac­cord­ing to the re­vised bud­get law, lo­cal gov­ern­ment debt was placed un­der lo­cal bud­get man­age­ment in 2015. Lo­cal gov­ern­ments’ fi­nanc­ing can be done only through bond is­suance in the fu­ture and is sub­ject to a debt ceil­ing. The ceil­ing can be ad­justed only upon ap­proval from the stand­ing com­mit­tee of the Peo­ple’s Congress.

The CNY 17.18tn ceil­ing in­cludes CNY 10.7tn of gen­eral debt and CNY 6.48tn of spe­cial debt. For ex­ist­ing non­bond li­a­bil­i­ties, the gov­ern­ment will use the debt-to-bond swap pro­gramme to swap ex­ist­ing debt with bonds of longer ma­tu­rity at lower cost. We ex­pect about CNY 5tn of lo­cal debt to be swapped in 2016, up from CNY 3.2tn in 2015. This will leave about CNY 6-7tn of debt (di­rect li­a­bil­i­ties) to swap in 2017. The swap pro­gramme will not in­crease the debt stock. We ex­pect to­tal lo­cal gov­ern­ment debt to de­cline to 35% of GDP in 2016 from 36% in 2015, as­sum­ing lo­cal gov­ern­ments strictly fol­low the re­vised bud­get law and fi­nance their debt only through bond is­suance.

Ed­u­ca­tion, tech­nol­ogy, so­cial se­cu­rity and health care have been high­lighted as key sec­tors to re­ceive fis­cal sup­port in 2016.

( Au­thors: econ­o­mists from Stan­dard Char­tered Bank ( HK) Lim­ited)

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