Economic stimulus Beijing-style: I treat, you pay
Beijing may criticize American consumers for spending money they do not have, but the truth is Chinese leaders do the same, they just make sure it doesn’t end up on their account.
In its $585 billion economic stimulus package, the central government is contributing just a quarter of the funds needed, leaving the rest of the tab to banks, local governments and the private sector.
By comparison, the U.S. Treasury is expected to fund all of America’s $787 billion economic recovery plan by incurring more debt through the issuance of Treasury bills.
But just like in the West, there’s no such thing as a free lunch.
The Chinese central government might have successfully transferred most of the risks and financing costs to banks and local governments from its own balance sheet, but if bad debt piles up the chickens will still come home to roost in Beijing.
China and the United States leverage themselves in different ways. America uses government credit to raise money directly from the market. China uses quasi-government financing, so that the real costs of the plan — though indirectly ultimately a cost to Beijing — are impossible for investors to gauge.
Beijing will have no trouble finding local governments and banks eager to help finance the stimulus plan for two reasons: it’s in their political interest to please the central authority, and with liquidity abundant, they are eager to lend and projects in the stimulus plan at least have government backing.
Indeed, a record for new yuan lending in January shows banks have already responded to Beijing’s call to support stimulus efforts. But there is a serious downside to the Chinese model.
“The main problem with relying on banks rather than incurring a larger explicit budget deficit is one of transparency,” said Tao Wang, head of China economic research at UBS. “Relying on bank financing makes it less transparent how much spending takes place in relation to various stimulus projects.”
China’s budget deficit is expected to swell only modestly due to spending associated with its economic recovery plan, to 3 percent from 0.6 percent last year. In contrast, the U.S. federal deficit will shoot up to 12.3 percent this year from 3.2 percent.
WHY IS BEIJING SO KEEN?
Many economists say they do not understand why Beijing is so keen to keep the financing off its books. The state’s balance sheet is probably the strongest in the world and they have no qualms about using state power to drive economic growth.
Some Chinese economists think the government is trying to avoid the scrutiny of the National People’s Congress. But the NPC has traditionally behaved as a rubber stamp parliament and there is little reason to believe that would change now.
Hongbin Qu, HSBC’s China economist, reckons that it just comes down to the Chinese way of doing things. He cited the way Beijing handled the costs of last year’s Sichuan earthquake as an example — the central government called upon 21 richer provinces to each partner with a heavily hit county to take responsibility for the rebuilding efforts.
“The Chinese government is used to buying a meal and getting someone else to pay,” Qu said. “The central government really should dole out more money because public service is its responsibility.”
Beijing has used smoke and mirrors to maximize government spending in the past. The previous administration issued government debt of $746 billion to fund almost $3 trillion worth of projects to pull China out of the Asian financial crisis — again ultimately spending four times what it put in.
Beijing has asked banks to issue low-interest “policy loans” of more than 10 years to local government entities for stimulus-related infrastructure projects. With very little down payment for the loan required, the banks have no buffer built in for potential downsides. Moreover, investors will not know how much those potentially problematic loans are, as it will just be part of the overall bank lending.
If this approach is pursued heavily, it could eventually put at risk banks’ balance sheets, their reputations and investor confidence. But again, because the projects are ultimately backed by the central government, the banks are only too happy to lend.
Also worth watching will be debt issued by local government investment vehicles. Local governments are not only expected to contribute to the 4 trillion yuan stimulus package, they have also pledged 18 trillion yuan to supplement the national plan.
But local governments don’t have the money and are not legally allowed to run deficits or borrow. They get around this restriction by setting up vehicles that package their debt like company debt, which is expected to flood the market this year.
Many of these vehicles generate little profit on the operating level and the debt is guaranteed by equally weak companies, but they still get triple A ratings because of the implicit guarantee by the government.
“On the surface the government has little financial burden but the reality is it just put risks at another place,” said Vincent Chan, head of China research at Credit Suisse.
— At the time of publication Wei Gu did not own any direct investments in securities mentioned in this article. She may be an owner indirectly as an investor in a fund. —