How to look at it?, Lou Jiwei suggests increasing fiscal deficits and avoiding large-scale debt swaps. Ministry of Finance | Finance | Fiscal Deficit

Under the pressure of economic growth, the trend of fiscal policies that shoulder the responsibility of stabilizing growth has attracted much attention. Lou Jiwei, President of the China Finance Society and former Minister of Finance, suggested increasing the fiscal deficit and preventing large-scale debt swaps, which has attracted industry attention. However, it remains to be seen whether this suggestion can be implemented.

Does fiscal stimulus rely on increasing fiscal deficits?

Lou Jiwei recently wrote an article in the Economic Daily discussing the focus of achieving high-quality development, believing that maintaining an appropriate growth rate is the top priority.

If there are no special circumstances, the economic growth rate this year will exceed 5%. Considering last year's low base, which is still lower than the potential growth rate, it is not conducive to maintaining full employment. Adding external unfavorable factors, it is necessary to increase the expansion of fiscal and monetary policies. It is necessary to appropriately reduce interest rates, and more importantly, adjust the budget in a timely manner to increase the fiscal deficit. The main purpose is to increase the central deficit, with most of it used for phased subsidies such as rent, water and electricity, and interest for small and medium-sized enterprises. Depending on the operating conditions of enterprises, fiscal subsidies can be directly credited to the account. A small portion can be transferred to local governments to alleviate local financial difficulties, while resolutely punishing arbitrary fees and fines, and creating a good business environment. Appropriately increasing local fiscal deficits is mainly not for new construction projects, but to make up for them. "The outstanding funds of existing projects," Lou Jiwei wrote in the article.

In a recent interview with China Daily, he stated that it is recommended to increase the deficit by 1.5 trillion to 2 trillion yuan this year, mainly to increase the central fiscal deficit, with most of it used for phased subsidies for small and medium-sized enterprises such as rent, water and electricity, and interest. Using central government funds to issue consumption vouchers is also a possible policy option to expand demand, but the most crucial policy focus still lies in protecting market entities. The most important thing is to ensure the normal operation of small and medium-sized enterprises, so that they can expand and provide employment opportunities.

In fact, since April, some economic indicators have weakened, and the downward pressure on the economy has increased. Some experts also suggest that the intensity of active fiscal policies should be increased, and measures such as increasing fiscal deficits can be considered. However, in recent years, it has been relatively rare to increase the fiscal deficit through budget adjustments in actual policy implementation. The last time this was done was more than 20 years ago.

In response to the new economic situation, the State Council executive meeting in mid June discussed a number of policy measures to promote the sustained recovery of the economy, including increasing macroeconomic policy regulation. At the expert symposium on the economic situation of the State Council on July 6th, it was requested to pay attention to the combination of policies, and timely introduce and implement a number of targeted, combined, and collaborative policy measures around stabilizing growth, employment, and risk prevention.

This has raised expectations for increased fiscal policy from the outside world, but there are also different opinions in the industry on whether to adjust the budget to increase the fiscal deficit.

Wen Laicheng, a professor at the Central University of Finance and Economics, told China First Finance and Economics that if it is difficult for the overall economic growth to reach the expected goal this year, we can indeed consider increasing the fiscal deficit and promote economic growth in a reasonable range by issuing additional treasury bond or local debt.

Yang Zhiyong, Director of the Finance and Taxation Research Center of the Chinese Academy of Social Sciences, told First Financial that expanding the fiscal deficit can be an option to boost proactive fiscal policies, but it depends on the situation. At least the conditions for implementation are not yet visible.

In the "Report of the State Council on the Central Accounts for 2022" released to the public in early July, the Ministry of Finance revealed the key work arrangements for the second half of the year. Among them, the top priority is to increase efficiency and implement active fiscal policies, thereby promoting sustained economic recovery and achieving effective improvement in quality and reasonable growth in quantity.

The specific measures revealed in the report to enhance fiscal efficiency in the second half of the year did not involve increasing fiscal deficits, but mainly focused on improving the efficiency of implementing existing proactive fiscal policies. For example, closely monitoring the execution of local and departmental budgets, strengthening budget execution and centralized treasury collection and payment management, comprehensively improving the efficiency of fund payment, and quickly forming physical workload.

Yang Zhiyong believes that actively implementing fiscal policies to enhance efficiency requires hard work in fiscal management, which is particularly evident in budget execution. The proactive fiscal policy of increasing efficiency has been fully reflected in the annual budget, so the current focus is on budget implementation. The budget has been arranged, and if expenses cannot be made in a timely or even impossible manner, it will inevitably affect the physical workload.

Although there is currently no official mention of increasing the fiscal deficit, the State Council has previously emphasized the need to strengthen policy reserve measures. Experts generally believe that increasing fiscal deficits can be one of the reserve policy measures. In addition, it also includes the issuance of special treasury bond, the use of special debt balance, policy development financial instruments and other policy tools.

Is implicit debt swap feasible?

At present, the overall risk of local government debt in China is safe and controllable. However, some local government debt risks are relatively high, especially the pressure of repayment of principal and interest on implicit debt, which has caused market concerns. The so-called implicit debt refers to the debt that is borrowed directly or promised to be repaid with fiscal funds or illegally provided guarantees beyond the statutory government debt limit.

In the recent executive meeting of the State Council, a series of policy measures to promote sustained economic recovery have been studied, which clearly include preventing and resolving risks in key areas. Since the beginning of this year, some local governments have claimed to strive for pilot policies to resolve hidden debts at the county level. This has raised expectations of local debt issuance replacing implicit debt.

According to institutional analysis, after the 2014 local bond audit, in order to replace local government debt in the form of non-governmental bonds, China issued approximately RMB 12.36 trillion worth of replacement bonds from 2015 to 2019. In order to alleviate the risk of local government debt, a total of approximately 1.1 trillion yuan of special refinancing bonds were issued from 2020 to June 2022 to replace existing implicit debt. However, since June 2022, China has not yet issued special refinancing bonds to replace implicit debt.

Lou Jiwei told China Daily that resolving the risk of local government debt through debt swap will trigger moral hazard, leading to an increasing scale of local debt. We must adhere to the bottom line of the central government's "resolute refusal to rescue" and gradually resolve the risk through debt extension, asset sales, and other means.

"We have done debt swap before, and now it is getting bigger and bigger than before. Doing it again will be even bigger, and we cannot do it again," said Lou Jiwei.

He stated that it is expected that there will be no large-scale thunderstorms on local government debt, and there is currently an increasing tendency to exaggerate the risks of local debt and put pressure on policies.

Wen Laicheng believes that the current scale of implicit debt is relatively large, and solving the problem of implicit debt still requires addressing the institutional mechanisms behind its formation. After the first large-scale replacement of implicit debt, it is necessary to be particularly cautious when implementing the replacement of implicit debt with local government debt on a large scale again. Resolving existing implicit debt still requires a combination of multiple approaches. Of course, for a few areas with extremely difficult finances, a small portion of implicit debt replacement can be adopted to alleviate the crisis, provided that relevant conditions are met.

At present, the official has not disclosed the scale of implicit debt nationwide. The Ministry of Finance publicly stated last year that the current growth momentum of implicit debt has been curbed, with implicit debt reduced by more than one-third, and the risk mitigation of local government implicit debt is controllable. Guangdong, Beijing, and other financially strong provinces have taken the lead in achieving no implicit debt across the entire region. There are many methods to mitigate implicit debt risks, such as directly arranging financial funds for repayment, transferring government equity and operating state-owned asset rights for repayment, and debt swaps.

Several financial and tax experts have told First Financial that allowing some regions to issue refinancing bonds to replace some eligible implicit debts can reduce interest burden by extending the term and alleviate local debt repayment pressure in the short term. However, this amount cannot be large-scale and has corresponding constraints. In the medium to long term, truly resolving local debt risks still relies on sustained economic growth, clarifying the relationship between the government and the market, promoting institutional and mechanism reforms such as finance and taxation, establishing a long-term regulatory system, and truly eliminating the soil environment for the formation of implicit debt.

According to data from the Ministry of Finance, the national local government debt limit for 2022 is approximately 37.65 trillion yuan, with an actual year-end debt balance of 35.06 trillion yuan. This means that by the end of last year, the distance from the upper limit of local statutory borrowing space was approximately 2.6 trillion yuan. This amount is also seen by some analysts as the upper limit of debt swap space.

The above report emphasizes that one of the key fiscal tasks in the second half of the year is to effectively prevent and resolve the risks of local government debt. Further strengthen local and departmental responsibilities, establish and improve a long-term mechanism for preventing and resolving hidden debt risks of local governments. Urge provincial governments to increase their efforts in city and county work, based on their own efforts, coordinate funds, assets, resources, and various policy measures to prudently resolve hidden debt stocks, and gradually reduce risk levels.

In order to avoid moral hazard, the Ministry of Finance has repeatedly reiterated in recent years that it adheres to the principle of no central assistance in resolving implicit debt, and achieves the goal of "holding the child of each family". The State Council has also made it clear that provincial-level party committees and governments should take overall responsibility for local debt risks, implement provincial-level government responsibilities, strengthen the main responsibility of cities and counties according to territorial principles and management authority, and resolve debt risks through increasing income and reducing expenses, realizing assets, and other means.

Yang Zhiyong believes that in order to prevent and resolve local debt risks, on the one hand, more effective data is needed, which is the foundation for solving the problem; On the other hand, creative measures are needed to solve problems in development.