China’s finance ministry is eyeing local debt issues before tackling broader economic challenges

BEIJING — China’s Finance Ministry’s news conference over the weekend highlighted how it is focusing on tackling local government debt problems instead of the stimulus markets had been expecting.

In his opening remarks on Saturday, Finance Minister Lan Fo’an outlined four measures, starting with increased support for local authorities to deal with debt risks. Only after emphasizing the four points did Lan tease that the country was aiming to increase its debt and deficit.

“The news conference is consistent with our view that addressing the funding struggle of local governments is a priority,” Robin Xing, chief China economist at Morgan Stanley, and his team said on Sunday. The central government is also expected to play a bigger role in debt restructuring and stabilizing the housing market.

“However, we believe the expansion of consumption support and welfare spending is likely to remain gradual,” Morgan Stanley analysts said.

China’s slumping housing market has cut into a significant source of revenue for local governments, many of which were struggling financially even before they had to spend on Covid-19 measures. Meanwhile, weak consumption and generally sluggish growth have multiplied calls for more fiscal stimulus.

The four policies announced by the Finance Ministry are more focused on addressing structural problems, Chinese economic think tank CF40 said in a report on Saturday.

“They are not specifically intended to address macroeconomic problems such as insufficient aggregate demand or falling price levels through Keynesian-style fiscal expansion,” the report said, referring to expectations of greater government intervention.

CF40 estimates that China does not need additional fiscal financing to meet its annual growth target of around 5 percent, as long as the spending it has already announced takes place by the end of the year.

Finance Minister Lan said on Saturday that the central government will allow local governments to use 400 billion yuan ($56.54 billion) in bonds to support spending on wages and basic services.

He added that a comprehensive plan to tackle hidden local government debt would be announced in the near future, without specifying when. Lan claimed hidden debt levels at the end of 2023 were half of those in 2018.

Historically, local governments have been responsible for more than 85 percent of spending but received only about 60 percent of tax revenue, Rhodium Group said in 2021.

Limited local government finances “have contributed to downward pressure on prices,” the International Monetary Fund said in an Aug. 30 report on China.

The core consumer price index, which strips out more volatile food and energy prices, rose 0.1 percent in September from a year ago. This is the slowest since February 2021, according to the Wind Information database.

For Morgan Stanley, solving the local government debt problems is a “critical step” towards halting the downward trend in prices – almost as important as the stimulus aimed at boosting demand.

After a flurry of political announcements over the past few weeks, investors are eyeing a meeting of China’s parliament expected at the end of the month. China’s legal process requires it to approve changes to the national budget. Last year’s meeting, which ended on October 24, oversaw a rare increase in the fiscal deficit to 3.8 percent from 3 percent, according to state media.

Analysts are divided on the specific amount of fiscal support that is needed, if any.

“Whether it’s 2 trillion [yuan] or 10 trillion, for us it actually doesn’t make that much of a difference,” Vikas Pershad, fund manager at M&G Investments, told CNBC’s “Squawk Box Asia.” “Our bet on China is a bet for several years. . Chinese stocks are undervalued.”

He emphasized that the direction of the policy is “on the right track” regardless of the size of the stimulus.

Pershad has talked about buying opportunities in Chinese stocks since January, but said on Monday that the latest burst of activity in the region had not made him more active in the sector.

China’s policy makers have generally remained conservative. Beijing did not distribute cash to consumers after the pandemic, unlike Hong Kong or the US

Julian Evans-Pritchard, head of China economics at Capital Economics, said at least 2.5 trillion yuan of additional financing is needed to maintain growth of around 5 percent this year and next.

“Anything less than that and I think the risk is that the economy continues to slow down next year given all the structural headwinds it’s facing,” he said on CNBC’s “Squawk Box Asia” on Monday.

Evans-Pritchard insisted that fiscal policy is more critical to addressing the latest economic crisis because China’s other support tools have previously included real estate and credit, which are not as effective this time.

“It’s hard to put a number on it because obviously there’s a lot of talk about recapitalizing the banks, solving the debt problems that exist among local governments,” he said. “If a lot of the additional lending is going to those areas, it’s not actually boosting current demand that much.”

— CNBC’s Sonia Heng contributed to this report.