How Economic Freedom Gave Birth to Chinese Deficit Spending
Calls increase for driving China's deficit ratio above the 3% threshold
Xia Lei (夏磊) chief economist at Guohai Securities, concludes there is still ample room to raise China’s deficit ratio, after reviewing its history of deficit spending and Treasury issuance since the reform era that commenced in the late 1970’s.
In a recent online opinion piece, Xia points out that the history of modern deficit spending in China really begins with the reform and opening era at the start of 1980's, when Beijing commenced its transition away from its traditional Communist command economy roots.
According to Xia, from 1968 to 1978 - a period which coincided with much of Mao's Cultural Revolution, China had no internal or external debts, as it endeavoured to create an autarkic, self-sufficient economy along the lines of the Soviet Union.
Following Deng Xiaoping's assumption of power in 1978 and the start of market-based reforms that would transform the Chinese economy, Beijing began to gradually increase its level of deficit spending and government bond issuance
"In 1981, the Chinese government began to experiment with fiscal deficits, restoring the issuance of Treasury bonds with a 4 billion issue," Xia writes.
By 1987 Treasury bonds issuance breached the 10 billion yuan threshold, marking the normalisation of regular Treasury issues to support deficit spending.
"This marked the start of experimentation with deficits as a fiscal tool for economic adjustment, and the abandonment of the zero debt concept," Xia writes.
China's attitude towards deficit spending remained cautious, however, with official statements pointing the need to contain to reduce such expenditures.
The 1985 fiscal budget report stated that a "small deficit" was "overall not positive for the prices of goods and market stability, and the development of the national economy."
The 1987 fiscal report called for "elimination of the deficit, while in 1989 the 5th Plenary Session of the 13th Communist Party Central Committee called for "gradually eliminating the deficit" over a time period of three years.
By the 1990's, however, attitudes had changed, and Treasury issues expanded to become an integrate part of active fiscal policy and China’s macro-economic toolkit.
1994 saw treasury issuance reach 100 billion yuan for the first time, before rising to 150 billion yuan in 1995, and 184.8 billion yuan in 1996.
In 1998, China issued 270 billion yuan in special treasury bonds, to provide capital injections to a moribund banking sector, which was at the time crippled by support for the country's ailing state-owned enterprises.
The gateway to further deficit spending opened further in 2014, with amendments to the Budget Law (预算法) that permitted local governments to issue their own bonds to fuel regional deficit spending.
The term "local government fiscal deficits" would then make its debut appearance in China's Government Work Report for the following year in 2015.
By 2016, China's deficit ratio hit the "3% international warning line" for the first time, as Beijing endeavoured to maintain growth in the years following the Global Financial Crisis, and at the outset of worsening economic relations with the US under a Trump presidency.
How China's deficit ratio is determined
In official procedural terms, the deficit ratio is approved and announced by the National People's Congress - the Chinese government's legislative body, every year in March at the annual "Two Sessions" meetings.
The ratio is usually in line with signals sent by the Central Government Work Meeting held by Beijing the end of the previous year.
According to Xia, three main factors determine the deficit ratio set by Beijing:
The economic growth rate.
The debt ratio.
The debt term structure.
China could drive deficit ratio past 3% ceiling
China now appears set to continue further along the path of deficit spending to support economic growth.
At the start of the year, Beijing announced plans to issue one trillion yuan in ultra-long-term Treasury bonds with terms of up to half a century this year, with further issues to follow over the next several years.
Beijing also signalled the launch of greater fiscal stimulus in September, with many domestic economists insisting on at least 10 trillion yuan in spending - an amount that dwarfs the 4 trillion yuan rescue package which arrived following the GFC.
Xia expects that China will soon exceed its current ceiling on the deficit ratio of 3%, given the long-term experiences of advanced economies with debt-expanding fiscal stimulus.
"Many advanced economies have adopted deficit ratios above the 3% red line to deal with around economic downturns," Xia writes.
"After the US subprime crisis, the European Union quickly broke through the 3% limit, and from 2009 - 2013 its average deficit ratio was 4.6%.
"For the US, for the 40 years from 1984 to 2023, the Federal Government's average annual deficit ratio was 3.8%, exceeding 3% for 24 years.
"Especially when faced with economic downturns, US fiscal policy became more active."