As China’s government debt will edge up modestly to 37.5% of GDP in 2017 and only rise slightly next year, Moody’s analysts rate China’s fiscal strength at “Very High.” In their April 12 report titled “Fiscal Impulse Larger than Deficit Implies; Credit Impact Depends on Sustainability of Growth,” Marie Diron and colleagues said they believe the general budget alone won’t be sufficient to sustain China’s GDP growth of 6.5%.

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China targets a moderate budget deficit of 3% of GDP in 2017

Providing insight into fiscal and quasi-fiscal sources of stimulus and potential credit implications for the sovereign, Diron and team highlight that China’s government is targeting a budget deficit at 3% of GDP for 2017, the same as last year. As the government has a number of funding sources such as the Central Budget Stabilization Fund and central government state-owned capital operations, the analysts believe the fund transfers to and from such sources will ensure that the fiscal balance outturns matched the budget targets.

China's fund transfers

 

The analysts argue that the actual fiscal impulse from the government will be substantially higher than what the headline numbers indicate. They point out that in the event that the GDP growth target doesn’t adjust in line with the economy’s potential slowdown, a larger net drawdown will be made from the funds to meet the targets. The Moody’s analysts highlight that during the last two years, such fiscal impulse has been significant, edging towards 4% of GDP, though the official deficit outcome was below 3%.

Quasi-fiscal activity will buttress China’s economic expansion

Taking cues from documents released during the NPC, Diron and colleagues point out that during 2017, China’s fiscal policy will be similar to what was adopted in 2016 by largely focusing on targeted tax cuts for small and medium industries and lowering administrative fees. However, the analysts believe the support from fiscal budget alone won’t help sustain the targeted 6.5% GDP growth, and China has to resort to quasi-fiscal spending and off-budget activities by the broader public sector to stabilize the country’s economic expansion.

Focusing on China’s credit profile, the Moody’s analysts highlight that the Chinese government’s ability to sustain growth, even in the short term, underscores the country’s high rating. They believe if public sector spending and lending maintains rapid growth in GDP in the short term, while contributing to medium term risks to growth and financial stability would be credit negative for the sovereign.

Diron and team believe the rise in direct government debt as a result of fiscal stimulus over the next couple of years will be credit neutral. However, the analysts believe in the event of substantial shock to China’s economy, government funds can only offer minimal support, though the public sector can play an active role to bolster the country’s economic growth, which could increase the country’s contingent liabilities and direct government debt, both of which would turn out to be credit negative. And as we have noted in the past, that may not end too well.