Lex on T notes, storm coming?

China’s fiscal policy
Published: January 6 2011 10:14 | Last updated: January 6 2011 16:22
A few days into 2011, and one of its big themes is already obvious. While most of the world’s biggest economies are committed to monetary looseness and fiscal tightness, China is doing just the opposite. Beijing is using a full array of tools – interest-rate increases, reduced loan quotas, bespoke reserves requirements for individual banks – to counter the fastest inflation in two years. Meanwhile, it plans to continue spending big sums on public housing and other public works. In officialese, monetary policy has shifted from “proactive” to “prudent,” while fiscal policy remains “proactive”. The latter could actually be imprudent.

At this juncture, monetary tightness is clearly appropriate: between the end of 2007 and the end of last year, growth in China’s broad money stock outpaced nominal gross domestic product by 25 percentage points. Fiscal looseness is another matter. In the 30 years to 2008, Beijing’s budget balance showed a cumulative deficit of a little over Rmb3,000bn. In the past two years it has overspent by about Rmb1,800bn, and reportedly envisages another Rmb900bn shortfall this year.

By global standards, China’s deficits are hardly alarming. Last year’s central government shortfall of about 2.7 per cent of GDP was just the right side of the old eurozone divide between healthy and risky economies and the total was less than America’s deficit in a single month (July). But restraint, once abandoned, is hard to recapture. Credit Suisse notes parallels between the past three decades in China and America’s “Gilded Age” of the late 19th century, after which the social focus shifted from economic efficiency to equality. US public finances never recovered.

If, amid this current spending, another round of bank recapitalisations is necessary to offset property losses – China is home to almost half of all skyscrapers being erected around the world – or if local governments’ financing vehicles really wobble, the government deficit really could start to take on Western dimensions. China, just like everyone else, is in uncharted territory.

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