In a major fiscal maneuver to stabilize its economy, China has launched an unprecedented package valued at 10 trillion yuan ($1.4 trillion) aimed at easing debt repayment pressures for local governments. Facing mounting financial constraints, an ailing real estate market, and deflationary pressures, the world’s second-largest economy seeks to rejuvenate domestic demand and stimulate growth. The initiative, which enables local governments to restructure “hidden debt” or off-balance-sheet obligations, marks one of China’s most extensive efforts yet to combat its ongoing economic slowdown.

Background: Economic Challenges and Pressures

In recent months, China has been grappling with substantial economic headwinds. Key issues include weak domestic demand, a crisis in its property sector, and mounting financing strains on local governments. A lack of consumer spending has contributed to deflationary pressures, complicating the nation’s ability to recover post-pandemic and address systemic vulnerabilities within its economy.

The downturn has reignited debates on China’s growth model, heavily reliant on infrastructure spending and property investment to drive expansion. After decades of rapid growth, China’s economy now faces structural challenges, including an aging population, stagnating productivity, and a shrinking labor force, that limit its growth potential. Furthermore, the rise in global interest rates, U.S.-China trade tensions, and geopolitical uncertainties compound the country’s economic troubles, making a comprehensive economic stimulus essential.

The Debt Swap Mechanism: Reducing Systemic Financial Risks

The new fiscal plan grants local governments the ability to allocate 10 trillion yuan toward reducing their hidden debts, including liabilities accrued by Local Government Financing Vehicles (LGFVs). These financing entities are responsible for implementing large infrastructure projects critical to local economies, but have accrued substantial debt over the years, especially since the 2008-2009 global financial crisis. These obligations often remain off the official balance sheets of local governments, posing a systemic risk to the financial system.

A core component of the plan involves raising the local governments’ debt quota by 6 trillion yuan, while enabling the use of an additional 4 trillion yuan from previously approved issuances. This restructuring is intended to lower the debt burden by substituting higher-interest liabilities with cheaper, longer-term debt instruments, potentially saving local governments 600 billion yuan in interest payments over the next five years. By stabilizing local finances, the Chinese government hopes to prevent broader financial instability while ensuring funding for essential projects.

Legislative Approval and Increased Debt Issuance Ceiling

China’s top legislative body, the National People’s Congress (NPC), has approved a bill raising the ceiling on local governments’ special bond issuance from 29.52 trillion yuan to 35.52 trillion yuan. Special bonds are typically allocated for infrastructure projects and other public goods, serving as a critical channel for local governments to raise capital. By increasing this ceiling, the central government aims to support infrastructure investment, stimulate demand, and create jobs, with the goal of keeping economic activity afloat during a challenging period.

The special bond program has been part of China’s fiscal toolkit for several years, designed to circumvent direct fiscal expansion limits. This approach provides financial flexibility for local authorities to initiate infrastructure projects without directly increasing central government debt. However, given the ballooning debt levels, there are growing concerns about whether China’s approach to economic management is sustainable in the long term.

Impacts on the Property Market and Local Economies

China’s property sector has been a significant drag on economic growth, as high-profile developers face liquidity crises, and property prices plummet in certain cities. The fiscal package includes measures to stabilize the housing market, such as encouraging state-owned entities to purchase unsold apartments and reclaim undeveloped land from distressed property developers. By absorbing excess housing supply, these interventions aim to restore investor and consumer confidence, stabilizing property prices and preventing broader economic fallout from the sector.

The property crisis has severely affected local economies, which depend heavily on land sales for revenue. As property demand wanes, local governments have struggled with declining land sales, depriving them of a primary revenue source. Measures to stabilize the property sector are thus integral to local governments’ ability to finance public services and fulfill debt obligations.

China’s Debt Burden: A Looming Risk?

Despite China’s ambitious plans to revitalize its economy, the scale of public and private debt remains a growing concern. Local government debt, including LGFV liabilities, has reached levels that worry financial experts globally. According to the International Monetary Fund (IMF), LGFV debt amounted to around 60 trillion yuan by the end of 2023, nearly 48% of the country’s GDP. Central and local government debt combined is estimated to be about 147 trillion yuan, representing 117% of GDP.

The implications of this debt overhang are substantial, as local governments face limitations on their ability to finance new projects that could stimulate growth. Consequently, China’s debt restructuring efforts primarily aim to alleviate the immediate burden on local governments, making room for future economic initiatives without drastically increasing the national debt burden. However, this balancing act remains precarious as mounting liabilities could hinder the government’s long-term economic strategy.

Fiscal and Monetary Policies: Broader Implications for China’s Growth

The debt swap program is part of a broader fiscal policy shift in China, which has included substantial monetary easing measures throughout 2024. In September, the government introduced larger-than-expected monetary stimulus measures to boost liquidity, which triggered investor speculation about an impending fiscal package. Financial markets responded positively, with Chinese stocks rallying amid hopes of a fiscal stimulus bonanza. However, economists caution that debt restructuring alone may not be sufficient to restore growth, especially without concurrent policies to boost domestic consumption and innovation.

Finance Minister Lan Foan emphasized the importance of coordinating fiscal support with monetary policy, particularly for state-owned enterprises (SOEs) and the financial sector. Lan announced plans to issue additional policies to bolster SOE purchases of unsold properties and to reclaim land from private developers, which could help stabilize the housing market. The minister also signaled intentions to recapitalize major state banks, potentially improving credit availability for private enterprises and small businesses.

Addressing Deflation and Demand Weakness

One of the main objectives of China’s current economic policies is to counter deflation. Unlike inflationary economies in the West, China’s economy has been flirting with deflation, primarily due to a prolonged period of weak domestic demand. As consumers continue to save rather than spend, a lack of demand growth has pressured businesses, particularly in the manufacturing and retail sectors.

Deflation poses serious risks as it discourages consumption and investment, creating a feedback loop that stifles economic growth. The fiscal stimulus aims to break this loop by making it easier for local governments to invest in infrastructure, which could create jobs and increase household income, stimulating demand. Additionally, the government’s policies supporting housing demand are intended to prevent further declines in property values, which have a significant impact on consumer wealth and spending habits.

The Road Ahead: Prospects and Challenges

While the debt swaps and additional stimulus measures are intended to stabilize China’s economy, challenges persist. Analysts warn that merely restructuring debt without addressing the underlying issues of weak productivity, aging demographics, and slowing innovation could hinder long-term growth. In the short term, the success of China’s economic recovery will hinge on whether the government can simultaneously stabilize the property market, stimulate consumer demand, and prevent financial risks from spiraling out of control.

China’s economic model is at a pivotal moment as it transitions from an investment-driven economy to one more reliant on domestic consumption and technological innovation. The current fiscal measures provide breathing room, but to achieve sustainable growth, China may need to implement structural reforms that encourage entrepreneurship, increase productivity, and reduce regional disparities.

Global Implications of China’s Fiscal Moves

China’s fiscal decisions also carry global implications. As the world’s second-largest economy, China’s slowdown impacts global trade and commodity markets, particularly in Asia, Latin America, and Africa, where Chinese demand has been a major growth driver. Additionally, if China successfully addresses its domestic challenges, it could stimulate global demand, benefiting economies worldwide. However, if these measures fail to restore growth, China’s economic troubles could lead to lower exports, reduced investments abroad, and increased protectionist policies, particularly given the rising tensions with the U.S.

In conclusion, China’s $1.4 trillion fiscal initiative reflects its commitment to preventing a deeper economic crisis by supporting local governments and stimulating demand. While the path to recovery is fraught with challenges, the ongoing efforts could play a crucial role in stabilizing China’s economy, provided they are part of a broader, long-term reform strategy. The success of these fiscal moves will not only shape China’s economic future but also influence global economic trends in the years ahead.

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photo source: Google

By: Montel Kamau

Serrari Financial Analyst

11th November, 2024