As 2019 gets under way and it becomes more clear that activity in the world’s three biggest economies – the United States, the euro zone and China – is weakening, businesspeople and investors are increasingly looking to policymakers in Beijing to unveil a stimulus package they hope will support growth and financial markets not just in China but around the world.
But although China rode to the rescue in 2009, and again in 2015-16, rolling out stimulus measures that boosted demand both at home and abroad, things are different this time around. While Beijing will loosen its policies to stabilise China’s domestic economy, anyone hoping for the kind of all-out stimulus effort big enough to provide a shot in the arm for growth and markets around the world is going to be disappointed.
To many observers, such a major programme looks ever more necessary. Almost 10 years after the last recession ended, the US economic cycle is looking increasingly long in the tooth.
With the US labour market at its tightest in 50 years and the Federal Reserve having raised interest rates from 0.25 per cent to 2.5 per cent to head off inflation, the economic headwinds are fiercer than in years. Ominously, in December the ISM index of US manufacturing activity registered its steepest monthly fall since October 2008, the month after the collapse of Lehman Brothers.
Last year, growth was supported by Donald Trump’s tax cuts, which went into force at the beginning of 2018. But with the House of Representatives back under Democratic control since last Thursday, no further such fiscal stimulus is on the cards for 2019. As a result, US growth is set to slow this year.
Activity is also softening in Europe. But with interest rates in the euro zone already negative, and the European Central Bank no longer printing money, there is little prospect of any boost from monetary policy. Meanwhile, the European Union’s budget rules prevent any significant fiscal stimulus.
So it is little surprise that people are looking to China for a policy stimulus lifeline, especially after local industrial profits fell in November and two closely followed indices of manufacturing activity turned negative in December, indicating a contraction for the first time in two years.
In recent weeks, observers have been getting excited at the prospect of major stimulative tax cuts from Beijing. In October, the authorities lopped some 500 billion yuan (US$72.8 billion) off individual income taxes. Now, following a high-level economic policy meeting in late December, China-watchers expect cuts in both value-added tax and corporate income tax rates over the next couple of months that together could be worth an additional 1.5 trillion yuan (US$218.5 billion).
Combined, these tax cuts would push the government’s budget deficit from roughly 3 per cent of China’s gross domestic product to more than 5 per cent. Such extensive cuts, say enthusiasts, would be even bigger in absolute terms than last year’s US tax cuts, supporting growth both in China and in the rest of the world through increased Chinese demand for imports, especially of commodities.
It’s a pretty story, but unfortunately it misreads how government finances in China actually work.
It is true that these tax cuts would substantially widen Beijing’s headline deficit. But the government’s official fiscal balance is largely meaningless. It only captures the central government’s budget and a small proportion of local government deficits. Most government borrowing and spending, especially capital investment on infrastructure, happens off balance sheet at the local government level. Factor this in, and China’s true budget balance has been running at a deficit of around 10 per cent of GDP for years.
Recently, this spending has come under pressure, as Beijing has moved to reduce risk in China’s shadow banking market, the source of much of the funding for local government infrastructure investment. As a result, overall credit growth in the economy has slowed from an annual rate of 15 per cent in early 2017 to less than 10 per cent in November. This decline in credit growth has been unaffected by Beijing’s efforts last year to inject liquidity into the banking system by cutting the proportion of deposits that banks are required to set aside as reserves.
Together, the decline in credit growth and fears of a deepening tariff war with the US have squeezed economic activity, pushing economic growth down to its lowest since early 2009 in the depths of the global crisis.
Whether the trade war escalates from here depends largely on the political whims of the US president. However, Beijing is already moving to stabilise domestic credit growth, for example by bringing forward and increasing quotas for local government bond issues to fund infrastructure investment.
But there is little chance of a credit binge of the sort seen in 2009, when credit growth leapt from 16 per cent to 33 per cent, or even of the scale of 2015-16, when it climbed from 12 per cent to 16 per cent.
There are several reasons for this. Firstly, Beijing continues to pursue the reduction of financial sector risk, as the government made clear following last month’s economic policy meeting. A general credit binge would undo much of that good work.
Secondly, rapid and widespread credit growth would risk re-inflating bubbles in China’s property markets, which remain overheated in many cities. Instead, Beijing will allow city governments to relax their targeted administrative measures to manage local prices.
Thirdly, the government is trying to engineer a structural transformation away from growth powered by investment towards an economy driven primarily by consumption. An investment boom now would be setting back that goal.
As a result, policy easing this year will be aimed at stabilising credit growth and maintaining economic growth at above the 6 per cent level, not at procuring the sort of pick-up in activity seen in 2009. And should the trade war with the US worsen, Beijing is likely to absorb much of the shock by allowing the yuan to weaken in the foreign exchange market.
Together, these measures should support activity in China’s domestic economy. But they will not lead to the sort of upsurge in Chinese demand for capital goods and commodity imports that foreign businesspeople and investors are hoping will boost economic growth in the rest of the world. In 2019, unlike 2009, Beijing is not about to throw the global economy a lifeline.
Read more at South China Morning Post, <click here>