Risk management

China needs to be proactive in responding to both internal and external challenges

Now, China is facing four key challenges in its international and domestic situations. First, geopolitical conflicts are on the rise globally. After the outbreak of the 2008 financial crisis, the world economy fell into long-term stagnation. Weak domestic growth has led some countries to intentionally internationalize domestic conflicts, claiming that their problems are caused by “unfair” economic and financial globalization. The COVID-19 pandemic further exacerbated the ebb of globalization. The China-US game is destined to be ongoing and long-term, while the Russia-Ukraine conflict, the Palestine-Israel conflict, and the Red Sea crisis have added uncertainties to international turbulence.

Second, the global industry and supply chains face restructuring. After the COVID-19 outbreak, many developed countries have begun to emphasize that the supply and industry chains should be closer to their domestic market and more diversified. The global chains have become more fragmented, localized and peripheral. The nearshore and friendly-shore outsourcing proposed by the US, as well as the so-called “China+1” strategy proposed by major developed economies, are clear examples. The restructuring of the global chains is harming the efficiency of resource allocation globally, thereby increasing the medium- and long-term production costs of many products, and consequently pushing up global inflation. The emphasis on security is weakening Chinese enterprises’ central status in the global chains, and posing challenges to foreign trade and investment.

Third, the domestic real estate market is undergoing transformation and adjustment. Domestically, the Chinese real estate market experienced rapid expansion between 2003 and 2018. Its development brought in a large amount of local government financial and tax revenues, promoted the growth of commercial bank loans, and propelled China’s economic growth, which has enhanced the wealth and well-being of residents. However, it has gradually brought about the problems such as imbalanced wealth distribution in the residential sector, local governments’ excessive dependence on real estate, and large-scale risk exposure by commercial banks. The principle of “housing is for living in, not for speculation”, which has been applied since 2017, has achieved phased success. Currently, not only developers and homebuyers, but also local governments have fundamentally changed their market expectations.

The new round of real estate regulation policies implemented around 2020 has decreased transaction volumes and housing prices. But if the real estate market continues to be deeply regulated, great pressure or too fast adjustment may trigger systemic financial risks.

Fourth, the fiscal and debt relations between central and local governments need to be reshaped urgently. With the implementation of the “housing is for living in, not for speculation” policy, the real estate market has gradually cooled down, making it difficult for local governments to sustain their land financing model. The three-year impact of the pandemic has reduced local fiscal revenue and increased fiscal expenditure, forcing local governments to balance their budgets through various means of borrowing. As the central government is exerting increasingly strict control on local government debt, the sustainability and potential risks of local government debt have become more prominent.

To better respond to the abovementioned challenges, China’s macroeconomic policies can be adjusted and optimized in the following aspects.

First, China should continue to prioritize economic growth and social development, and avoid falling into a “pan-security” trap. It is believed that just as the United States’ Star Wars program (Strategic Defense Initiative) in the 1980s dragged the Soviet Union into an arms race that ultimately led to the collapse of the Soviet economy, the US-led developed countries may be attempting to drag China into a “pan-security” trap, that is, creating international tensions and escalating Sino-US confrontation to lure the Chinese government into focusing excessive energy and resources on security at the expense of economic and social development. Chinese policymakers need to fully recognize the importance of sustainable growth, and focus on highquality development while defending the core national interests.

Second, China should spare no effort to maintain its central position in the industry and supply chains in Asia and along the Belt and Road routes. This means that in the future, China should better manage the Regional Comprehensive Economic Partnership and the Belt and Road Initiative, and be more active in its bid to join the Comprehensive and Progressive Agreement for Trans-Pacific Partnership. China still needs to be the flagship for globalization. It needs to strengthen its high-quality opening-up to attract foreign direct investment, and maintain industry and supply chain connections with developed economies such as the US and the European Union through various efforts.

Third, the development of China’s commodity housing market is relatively sufficient. In first- and second-tier cities, the future addition of real estate will mainly focus on the construction of affordable housing due to a roughly balanced supply and demand. In third- and fourth-tier cities, considering that a number of commercial houses are not selling well and there is still a high demand for affordable housing, a fund should be set up by the local government to purchase excess commercial housing from developers at a lower price and transform it into affordable housing to meet the needs of new residents. The funds for such housing projects can be provided by the central government through the issuing of special treasury bonds. On the one hand, the construction of affordable housing, urban village renovation, and emergency public infrastructure is expected to significantly speed up; on the other hand, there is still a large demand for the renovation of old commercial housing. Once the goal shifts from developing increments to operating stock, financial products such as real estate investment trusts (REITs) and mortgage-backed securities (MBS) will also develop rapidly.

Fourth, it is essential to reshape the relations between central and local fiscal debt if the risks of local government debt are to be fundamentally prevented and resolved. It is necessary to readjust and balance the financial and administrative powers of the central and local governments. This is the key to avoiding the debt of local governments increasing. It is essential that the central government coordinate expenses related to education, healthcare, social security and elderly care. Besides, important infrastructure investment in various regions should be financed by bonds issued by central and provincial governments, so as to realize the dual matching of term and cost benefit.

Furthermore, the government also needs to implement more expansionary fiscal and monetary policies: first, the central fiscal deficit ratio to GDP should be raised to over 4 percent, and the fiscal funds should give more support to residents and small- and medium-sized enterprises; second, the central bank should lower interest rates to avoid the negative impact on enterprise production and investment; third, efforts should be made to expand the issuance of treasury bonds, explore more sources of funds for the implementation of fiscal policies, and provide high-quality assets for the financial market. In the future, treasury bond issuance should be expanded to better coordinate fiscal policy with monetary policy.

The author is deputy director of the Institute of Finance and Banking at the Chinese Academy of Social Sciences and deputy director of the National Institution for Finance and Development. The author contributed this article to China Watch, a think tank powered by China Daily. The views do not necessarily reflect those of China Daily.

SONG CHEN / CHINA DAILY