China must "go deeper into the danger zone" of debt

Central bank uses window guidance to prevent stock market bubble. Li Qiang wants to spur vitality of Chinese private enterprise.

Our briefing on critical economic and financial developments in China as of Friday, 11 October, 2024:

• China’s central government needs to “go deeper past the red line” when it comes to debt levels, according to Renmin University professor Mao Zhenhua.

• Premier Li Qiang calls for “spurring the vitality” of private enterprise, immediately following China’s October vacation.

• The Chinese central bank has made recourse to window guidance to prevent commercial lenders from triggering a stock market bubble.

Chinese debt needs to "go deeper into the danger zone" to fuel fiscal stimulus: Mao Zhenhua

A leading Chinese economist has called for the central government to amass more debt, in order to drive fiscal stimulus measures that could expedite a recovery in economic growth.

On 26 September, the Politburo of China's Communist Party signalled plans to launch robust fiscal stimulus measures, triggering a bull run on both the mainland A-share and Hong Kong H-share markets.

The Politburo said that it would "expand the intensity of counter-cyclical fiscal and monetary policy," in order to deal with the challenges of faltering domestic demand from consumers and private investment.

Concerns have long abounded over China's debt-to-GDP levels, and a hefty fiscal stimulus plan will only contribute further to the Chinese government's mounting debt burden.

One leading Chinese economist argues, however that China still has ample room to raise its leverage levels to fuel fiscal spending.

Mao Zhenhua (毛振华), joint-head of the Economic Research Institute at China's prestigious Renmin University, writes that concerns over Chinese debt levels are overplayed.

"For some time now, whether or not Chinese government debt levels are too high and risk is controllable has been a focal point both at home and abroad," Mao wrote in a recent opinion piece.

"At present, there is still much noise surrounding active expansion of government debt, because excessive debt and high leverage is generally considered to be one of the fundamental causes of crises such as the Global Financial Crisis and the Great Depression."

According to Mao, however, the sum total of Chinese government debt - including central government debt and local government debt, as well as hidden local government debt in the form of the debts of local financing platforms, is roughly around 133 trillion yuan, for a leverage ratio of approximately 100%.

Mao points out that this leverage ratio is only slightly higher than that of Canada or Germany, as well as far lower than the figures for Japan, the US or the UK.

For this reason, Mao believes that "the ratio of government debt to GDP must break through the original red line," in order to support Beijing’s fiscal stimulus plans.

"We cannot place excessive concern on debt expansion, but must correctly acknowledge and expect that government debt should play a key driving role in counter-cyclical adjustments."

Mao makes the caveat, however, that China cannot "expand government debt without limit," and that any increases in leverage should be accompanied by prudent structural adjustments.

According to Mao, the Chinese central government should increase its leverage levels via the issuance of a greater volume of treasuries, given that its leverage ratio at the end of last year was just 23.8%.

The reason for this is that China's fiscal system since 1994 has made local government responsible for a disproportionate share of administrative expenditures, compelling some of them to amass encumbering levels of debt.

Mao also called for debt-fuelled fiscal spending to give greater support to households via measures such as subsidies, in order to boost domestic demand by raising the willingness of Chinese citizens to consume.

Premier Li Qiang wants to "spur the vitality of Chinese private enterprise"

China's senior-most policymakers have stressed the need to improve conditions for private enterprise in order to boost the recovery of the country's economy.

On 8 October, immediately following China's national vacation, Premier Li Qiang convened a meeting with domestic economic experts and entrepreneurs on current business conditions and policy recommendation moving forward.

"The key to stabilizing the economy is stabilizing enterprise," Li said.

"We must pragmatically help enterprises resolve their difficulties, lead the application of various policies to benefit enterprise, continually optimise the commercial environment, and spur the vitality of enterprise."

On the same date, Zheng Shanjie (郑栅洁), head of the National Development and Reform Commission (NDRC) also signalled greater accommodation of private enterprise when it came to legal enforcement.

"We must adopt more accommodating and prudential regulation and softer enforcement methods," Zheng said.

"We cannot apply fines, conduct investigations or shut businesses haphazardly."

Zheng also called for accelerating the passage of China's proposed "Private Enterprise Expediting Law," in order to provide an "excellent environment for the development of the non-state-owned economy."

China resorts to window guidance to prevent commercial banks from triggering a stock market bubble

Chinese financial regulators have resorted to "window guidance" to prevent commercial banks from fomenting the creation of a stock market bubble, following the launch of credit loosening measures by the central bank to prop up the economy.

State-owned media reports that on 8 October, financial authorities issued window guidance orders to Chinese banks that included the "strict prohibition of the use of loans to invest in the share market in breach of regulations."

The term "window guidance" is most commonly associated with the Japanese banking system, and involves the use of pressure or even direct compulsion by government authorities to guide the extension of credit by depository lenders.

China's latest spate of window guidance arrives just following a surge in domestic stocks prompted by the unveiling of credit loosening measures by the People's Bank of China (PBOC) - the Chinese central bank.

On 24 September, PBOC launched two new structured monetary policy tools to provide greater liquidity to institutional participants in the share market.

The move triggered accusations from critics that the Chinese central bank was in effect "buying up stocks" directly.

Leading Chinese economist Xiang Songzuo (向松祚) points out, however, that neither of the two new facilities involve expanding the balance sheet via the direct purchase of securities in the secondary market.

The announcement nonetheless led to a spike in the Chinese share market just prior to the start of the 1 October National holiday. By 30 September the SSE Composite Index had bounced back to 3300 points, before surging further after the end of the national celebrations to 3500 points by the close of trading on 8 October.

Prominent Chinese economist Mo Kaiwei (莫开伟) said that while the measures from PBOC were designed to bolster the health of China's capital markets so that it can play a greater role in the financial system in future, the abrupt response of investors compelled the central bank to reverse course by making abrupt use of window guidance.

"When a large volume of funds pour in, it can drive share prices higher, causing divergences from real values and creating a bubble," Mo writes.

"Strictly regulating the entry of banking funds into the stock market can prevent market manipulation and unfair competition."

The latest use of window guidance by Chinese authorities also calls for banks to focus on investor protections, as well as strictly control levels of leverage.