Prudent fiscal and monetary policies are still needed

Although it is necessary for China to eventually exit from expansionary monetary and fiscal policies, it is inadvisable for the country to fully cease such unconventional policies at present, as the world’s second-largest economy still faces potential gray rhino shocks.

The country ceased issuing special antivirus government bonds for COVID-19 control and stopped providing interest subsidies for loans granted to key enterprises guaranteeing supplies for pandemic prevention and control.

Unconventional policy measures will bring huge shocks to the order of the market economy if they last too long, as there will always be aftereffects from large-scale stimulus packages. Therefore, China must bring an end to unconventional policies. However, we should think carefully about whether or not the country should completely exit from expansionary monetary and fiscal policies.

The key to answering this question is twofold: First, whether China’s economic growth has normalized, with the output gap — an economic measure of the difference between the actual output of an economy and its potential output — being around zero. Second, whether the momentum of economic growth has normalized and will maintain stability over the short to medium term.

If we take a look at the current level of employment and the level of the core consumer price index, we will find that China’s level of output has not fully returned to trending tracks. We are not only facing problems of economic instability and disequilibrium but also gray rhino shocks which will lead to systemic changes.

One of the gray rhino shocks is that the external environment of China will likely face big changes at the end of this year and the beginning of next year for several reasons.

First, thanks to improved macroeconomic data, the US Federal Reserve may adjust expansionary monetary and fiscal policies, which will lead to huge changes in the world’s liquidity and financial environment.

Second, despite uncertainties during the COVID-19 pandemic, the speed of global economic recovery is faster than expected, and the recovery of global supply and industry chains will also be faster than expected. This will quickly mitigate the problem of a mismatch between supply and demand around the world.

Third, the containment strategy that the United States adopted by rebuilding an alliance of democracies and reshaping supply chains to challenge China is advancing more rapidly than we imagined and may further squeeze the Chinese economy, going forward.

Finally, all countries will begin redesigning supply chains, industry chains and innovation chains after the COVID-19 pandemic, thus leading to major changes in the global division of labor system and the pattern of world trade.

We should watch out for the above situation, although we may think that the Chinese economy has returned to vibrancy because of the current boom of foreign investment and foreign trade. However, if China had not made strategic arrangements for domestic demand expansion beforehand, once the external economic factors reverse, the country may have a more serious excess capacity problem than it did in 2019.

The other gray rhino is the worsening of regional financial risks, which we have followed closely for many years.

As early as 2014, China paid close attention to the problem of a rapid increase in local government debt and the growth of hidden debt, but we made no substantial progress in solving the problem.

The country is now seeing an economic divergence in terms of regions, industries and businesses that, in addition to the distribution of debt by region, will create accumulative effects. As a result, the accumulation of local government debt — which is based on urban expansion and project investment and sees participation by local government financing vehicles, local financial institutions and local State-owned enterprises — will reach a new level.

To solve the local government debt problem, we must push ahead with reforms of local State-owned enterprises, local financial systems and local fiscal and tax systems over the next few years. The strategic deployment may truly dismantle various time bombs China faces.

These gray rhinos will reverse continuous expansion of external demand and make it unlikely for local governments to become engines driving economic recovery amid financial risk shocks. Therefore, China’s economic recovery in the second half and the beginning of next year will not be as smooth as optimists anticipate.

What deserves equal attention is that China will replace its old development strategy with a new one and fully implement its new dual-circulation development paradigm this year, which takes the domestic market as the mainstay while letting domestic and foreign markets boost each other.

The country must achieve economic recovery and growth amid the transition of growth drivers and strategic paradigms. This requires adjustment of the benefit mechanism, especially the establishment of incentive and restraint mechanisms that can adapt to the transition and new strategic deployment.

Current fiscal expenditure shows the lack of enthusiasm among local governments for investment is due to a lack of quality projects. In the second half of this year, the mechanisms promoting self-reliance and self-improvement in science and technology, “new infrastructure” and new technology deployment — as well as the establishment of complete domestic supply chains — are still imperfect, so that domestic demand expansion brought by China’s new strategy for development may not realize expected goals. Under such circumstances, if the country overtightens its monetary and fiscal policies, it may face several challenges.

First, it is hard for China to deal with external shocks that are beyond expectations.

Second, it is difficult to create a relatively loose environment for deep-level reforms.

Third, it is challenging to provide financial support for the full implementation of the new dual-circulation development paradigm and to create sufficient conditions for the upgrade of domestic circulation.

Fourth, the country’s positive economic data at the current stage do not yet warrant policy tightening.

Therefore, in my view, China should accelerate the pace of fiscal spending in the third and fourth quarters, especially in the third quarter. The country should also speed up total social financing growth and credit issuance rather than simply exit from expansionary monetary policies due to uneven and unsolid economic recovery and the potential for gray rhino shocks.

The country must achieve economic recovery and growth amid the transition of growth drivers and strategic paradigms. This requires adjustment of the benefit mechanism, especially the establishment of incentive and restraint mechanisms that can adapt to the transition and new strategic deployment.

CAI MENG / CHINA DAILY