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Tom Rafferty: Don't hold your breath for a Chinese stimulus rescue

Global financial markets have been rallying after a difficult few months. Oil prices have bounced back to around $40 a barrel and iron ore prices rose by nearly 20% on a single day in March. Partly driving these gains are expectations that fresh fiscal stimulus in China will help to lift demand in the world's second-largest economy.

     Claims that China is set to embark on fiscal stimulus do not stand up to close scrutiny, however. At the recent meeting of the country's legislature, Premier Li Keqiang did reveal that the government this year is targeting a bigger fiscal deficit, equivalent to 3% of gross domestic product. This compares with a published deficit of 2.4% in 2015 and, if realized, would mark the widest official shortfall since 1979. The government wants economic expansion to reach 6.5-7% in 2016.

     However, Li was putting a generous spin on the numbers. Monthly data provided by the Ministry of Finance shows that the government ran a fiscal deficit last year equivalent to 3.5% of GDP. This data is closely consistent with the final annual accounting generally, but on this occasion the finance ministry transferred an unusually large amount from other sources -- around 800 billion yuan ($123.4 billion) -- into the revenue column. This was enough to bring the deficit roughly in line with the budgeted level of 2.3% and save the government the embarrassment of significantly overshooting its target.

     This sort of creative accounting will do little to assuage investor fears at a time when Chinese economic statistics are already treated with widespread derision. But with the deficit for 2016 set to come in below the actual level recorded in 2015, it also means that expectations for stimulus in China this year ought to be tempered. Claims by the authorities that they will adopt "more proactive" fiscal policies may have been aimed at domestic and international audiences concerned about the slowing trajectory of the economy.

ZOOMING IN   A close read of the 2016 budget supports the view that fiscal support from the government will prove limited. Contrary to expectations that public spending will be significantly boosted, the government is actually targeting a modest 6.7% increase in its spending. This would be roughly in line with likely nominal GDP growth and mark a significant slowdown from the 13.2% expenditure expansion in 2015.

     A strain on fiscal revenue is the main reason behind these conservative projections. Government income grew only 5.8% last year, below the targeted level, and is expected to increase just 3% in 2016. Tax restructuring and cuts play a role. However, the bigger drain on the government's coffers has been weak economic activity and a slowdown in housing construction.

     Payments collected by local governments from the sale of land-use rights, typically equivalent to around half of their revenue, slumped by nearly 20% in 2015. The finance ministry expects this figure to decline again this year. This leaves regional administrations struggling to meet expansive expenditure requirements unless the central government boosts fiscal transfers to them. The 2016 budget therefore quite accurately reflects how the government has less fiscal policy flexibility than commonly perceived. Central government debt is low and the vast majority of it is held by domestic creditors. Yet local government debt remains worryingly high and an ongoing program to swap these debts into cheaper municipal bonds is only helping to ease the associated repayment burden, not eliminate it. The state also has potentially sizeable liabilities associated with struggling state-owned enterprises.

     The government still has options if it decides to prime the economy. Controls could be loosened over off-budget mechanisms, such as government-linked financing vehicles, although this would be at the cost of pushing back a reform agenda aimed at raising fiscal transparency. It could also choose to use on-budget measures before making adjustments to ensure that the final figures do not depart significantly from targets. Recourse to these accounting methods, however, might prove to be a trick difficult to play twice.

     Those betting on Chinese fiscal stimulus to salvage the global economy would therefore be advised to check their optimism. A close read of the government's own plans suggest this is an administration not preparing to embark on stimulus, but one struggling to weather the strains associated with an economic slowdown that has a good number of years yet to run.

Tom Rafferty is lead China analyst for the Economist Intelligence Unit in Beijing.

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