It’s the Economy Cupid

It’s the Economy Cupid

China has recently drawn fiscal bows from its policy quiver

Over the past few weeks, articles have spawned and multiplied about efforts to stimulate the Chinese economy through fiscal policy, see China Targets Stimulus. But few of these articles have examined how officials are attempting to breathe life into businesses and consumer spending. While China’s economy has been on a slow downward trend in recent years, a sharper-than-expected contraction took hold in 2018, due mainly to trade tensions with the US. The Chinese government has stepped in to arrest the slide and boost investment, as an all-important trade agreement continues to elude the two countries.

In the first quarter of 2019 local government authorities issued the equivalent of $179bn of bonds, in a dramatic turnaround from the previous two years, when the central government squeezed credit to deleverage regional balance sheets. Indeed, Moody’s[1] rating agency forecasts that ‘special purpose’ bonds, specifically used to finance construction, will have issuance levels 57 percent higher this year compared to last. Faced with worryingly low growth prospects at the start of 2019 (the lowest in thirty years), the Ministry of Finance decided to front-load bond allocations to stimulate growth through infrastructure investment. Time will tell whether refinancing costs from the new bonds will partly discount the effects of the stimulus.

In December last year, the government announced eight new railway construction projects worth an estimated $125bn. Roughly seven thousand kilometres of railway track will be added to China this year, a forty percent increase from 2018. Over half the financing will come from tax revenues and government debt contracts. And it appears these policy efforts are beginning to show. The official Purchasing Managers’ Index (PMI) rose to 50.5 in March from February’s three-year low of 49.2, marking the first expansion in four months.

While recent PMI data should come with a note of caution – Chinese factory activity typically picks up in the weeks following the lunar New Year holiday – other measures, such as a Rm2tn value added tax reduction aimed at intermediate manufacturing goods have led to a higher backlog of inventories for the rest of 2019. In addition, the government recently raised the floor below which income tax is paid. It seems good old-fashioned counter cyclical policies still do have credence (just don’t tell thatto the European Commission).