Fiscal Policy Decentralization and Monetary Policy Fiscalization - China’s Fiscal and Monetary Policy Systems: Flaws and Reforms
The Chinese government has recently announced a plan to raise the fiscal deficit for 2020 by one trillion yuan over the previous year and to issue special COVID-19 Treasury bonds worth one trillion yuan. These are necessary and exciting measures for coping with COVID-19’s economic impact. However, China’s fiscal and monetary policies still have fundamental defects. First, the implementation of China’s fiscal policy has become the responsibility of local governments. Second, China’s monetary policy is burdened with extraneous fiscal functions. These policy defects greatly increase systemic financial risks exposing the central bank to potential huge losses, which, if materialized, would prevent it from taming inflation with monetary policy and acting as a lender of last resort to maintain financial stability.
Preparing for a New Long-term Recession
The COVID-19 pandemic is taking a toll on the world economy. The mid- and long-term world economic outlook is grim. In all likelihood, a new type of long-term recession is in the making. While the current priority is to curb the public health crisis, economic policymaking must strive to prevent a recession from spiraling out of control. Amid the pandemic, the role of fiscal policy comes into play, highlighting the importance of government debt management. The central bank should swiftly cut interest rates and ramp up the credit supply. In coping with the COVID-19 crisis, we must follow the principles laid out at the Third Plenum of the 18th CPC Central Committee in deepening domestic reforms, and implement the Belt and Road Initiative under the banner of building a community of shared future for mankind.
Quarterly Report on China’s Macro Leverage Ratio, Q2 2020
In the first half of 2020, China’s leverage ratio increased by 21 percentage points to reach 266.4%, up from 245.4% at the end of the previous year. In Q2 2020, China’s leverage ratio climbed by 7.1 percentage points, down from the 13.9 percentage points increase in Q1. Slowing growth in the leverage ratio in Q2 despite a small increase in debt growth over Q1 mainly arose from economic growth returning to the positive territory. If the economic recovery continues in the second half of 2020, we may expect slowing growth, and even a quarterly decrease, in the macro leverage ratio.
The rising corporate leverage ratio contributed 70% to the 13.9 percentage point increase in China’s macro leverage ratio in Q1 2020, while the government leverage ratio contributed 16% and the household leverage ratio contributed 14%. Increase in the corporate leverage ratio contributed 46% to the 7.1 percentage points increase in China’s macro leverage ratio in Q2, while increase in the government leverage ratio contributed 25% and increase in the household leverage ratio contributed 28%. Compared with Q1, the marginal contributions of the household and government sectors to the macro leverage ratio increased in Q2, prompting a reasonable adjustment in the leverage ratio structure.
While policy authorities have set a much higher credit growth target than in previous years, the sluggish real economy offers limited room for credit absorption, giving rise to a misallocation between credit supply and the real economy. This may lead to a substantial increase in the overall leverage ratio, financial arbitrage, and rising asset prices.