By Yu Yongding
BEIJING – When China’s GDP growth is below target, successive governments have relied on the same tool: government spending on infrastructure investment to stimulate the economy. But the success of fiscal stimulus requires getting the details of implementation right.
Two challenges stand out. The first is financing. While Chinese policymakers rely on fiscal spending to help achieve the official growth target, they are uneasy about the central government’s rising leverage ratio and about moral hazard at the local-government level. Given this, they are reluctant to finance infrastructure investment through the general public budget.
Instead, the authorities use other “budgeted funds,” including local-government special-purpose bonds (SPBs) and revenues from the sale of land rights. Such financing is augmented by “self-raised funds,” obtained mainly through municipal-bond issuance, bank loans, and state-owned enterprises.
One striking feature of the funding structure is that the more expensive a source is, the larger its share of total financing. So, the general public budget – which costs nothing, from an investors’ point of view – accounts for a small share. According to my estimates, in 2021, that share was 10.2%, with the central government’s contribution amounting to just 0.1%. Funds raised from municipal-bond sales – which are far more expensive – accounted for more than 30% of total infrastructure funding.
By relying on funds raised through the capital market and commercial banks, China makes its infrastructure investments far more costly than necessary. And while China’s approach of choice protects the central government’s deficit-to-GDP ratio, it places a heavy burden on local governments’ budgets, especially because infrastructure investment is generally unprofitable and unable to generate large cash flows.
But the fiscal position of China’s central government is much stronger than that of local governments. In fact, the central government has consistently run a budget surplus, which amounted to a comfortable 5.1% of GDP in 2021. Meanwhile, local governments, taken together, ran a budget deficit of 9.1% of GDP. This basic pattern holds even if one accounts for fiscal transfers to local governments. While shifting the burden of funding infrastructure investment to local governments does discourage moral hazard, the prevailing financing structure’s high costs, complexity, and lack of transparency are causing local-government debts to reach unsustainable levels – and the central government will eventually pay a high price.
The second major impediment to the effective implementation of expansionary fiscal policy in China lies in the inflexibility of local-government SPBs. When they were introduced, SPBs were hailed as a transparent way to fund infrastructure investment. And because they are relatively cheap, at least compared with self-raised funds, local governments embraced them.
But, fearing that local governments would mismanage SPBs, the central government imposed strict regulations on their issuance and use. For starters, local governments cannot issue SPBs directly. Instead, they must report their infrastructure projects and budgets to provincial governments, which then select proposals to present to the central government. After the central government approves a project, the provincial government issues SPBs, and allocates the funds raised to the relevant lower-level administration.
By the time funds are delivered to the relevant local government, however, they might no longer align with project needs, and neither the local government nor the firms responsible for construction can do much about the mismatch. Raising funds from the market to fill the gap is generally not allowed.
Reinforcing the rigidity of the current framework, allocated funds must be used in the same year the SPBs are issued – an impossible feat in many cases. And SPBs must be repaid from income generated by the projects they have financed. Because of this lack of flexibility, a material share of funds raised via SPBs has not been spent in recent years.
China is right to respond to below-target growth with fiscal (and monetary) expansion. But deciding on the direction of policy is only the first step. Leaving aside non-economic hard constraints such as the zero-COVID policy, China must also strengthen implementation, by addressing financing imbalances and constraints. In particular, the central government should consider financing a larger share of infrastructure investment itself, through the general public budget and the issuance of public bonds, as well as loosening SPB rules.
Copyright: Project Syndicate, 2022.
