China seen facing 'impossible challenge' on budget, tax and GDP

Li on Monday said this year’s deficit goal was cut to 2.6% of gross domestic product, from 3%, the first reduction since 2012. At the same time, he pledged tax cuts of 800 billion yuan for companies and individuals and set a 6.5% annual economic growth target - the same as last year’s target but slower than the actual performance of 6.9%.

“These targets suggest tight monetary conditions and tight fiscal policy, with GDP growth holding up, despite an intensified deleveraging campaign,” said chief Asia economist  Freya Beamish in London. “Something’s got to give. We reckon it’s fiscal policy, though monetary policy could also turn out on the easier side, with the yuan also set to weaken.”

Beamish says resurgent producer-price inflation and robust nominal growth that have boosted corporate pricing power and profits since 2015 are both set to ease this year, making it harder for indebted companies to cut debt.

“The government will have to continue with the same fiscal support as last year,” but also spend more and increase off-balance sheet borrowing, she said.

Alicia Garcia Herrero, chief Asia-Pacific economist at Natixis in Hong Kong, cites calculations showing China’s revenues as a percentage of output clearly declining since 2015. That’s a trend that hasn’t had any obvious policy response, she said in an email.

“The 2.6% does not look consistent with ample growth nor does it look achievable without fiscal reform,” she said.

While China is aiming for a narrower official deficit, leaders still plan to expand the issuance of special purpose bonds, which are sold by local governments to finance items that aren’t included in the general public budget and not counted in the deficit ratio released annually.

Local governments have used special bonds to help pay for highways, railroads and other construction projects in recent years, and the securities are designed to be covered by returns of the projects rather than general revenues.

Special purpose bond issuance will jump to 1.35 trillion yuan this year to prioritise “supporting ongoing local projects to see them make steady progress,” the Finance Ministry said Monday. That’s up from 800 billion yuan in 2017 and 400 billion yuan in 2016.

“While the general public budget deficit ratio is lowered, the deficit ratio covering all government accounts is largely stable,” Liu Liu, an analyst at China International Investment in Beijing, said in a note. The combined deficit of general public budget and overnment-managed fund budget could rise to 4.1% of GDP this year from 4% last year, Liu wrote.