context: Guo Shuqing 郭树清 China Banking and Insurance Regulatory Commission chairman’s previous remark on real economy reform and Xu Zhong’s blame for fiscal policy expose the difficulty in creating synergy among every responsible ministry in tackling ongoing economic challenges.

Xu Zhong 徐忠 People’s Bank of China (PBoC) Research Bureau director is advocating for active fiscal policies and fiscal reform, discussing

  • fiscal policies are not as active as Ministry of Finance (MoF) claimed
    • currently monetary policy is prudent and neutral, fiscal policy should be more active; 2.6 percent fiscal deficit this year is even lower than last year’s 3 percent, showing no sign of expansion
    • fiscal spending lacks institutional design for long-term, structural problems, such as implicit local government debt, gaps in pension funding, de-capacity, de-leveraging and real estate bubbles
    • while many tax rebate policies have been released in recent years, residents and private enterprises don’t feel it because
      • while the tax rate reduced, collection becomes stricter
      • SOEs and well-connected individuals enjoy tax cuts whereas tax on small enterprises and individuals has increased
  • capital shortage in financial state-owned enterprises (SOEs) becomes noticeable under financial de-leveraging; they should be financed by real fiscal spending
    • real economy liability is a mirror image of financial sector assets; financial sector leverage is passively raised, and malpractice reflects institutional problems in the real economy
    • while MoF acts as the state shareholder in financial SOEs, more things should be done
      • MoF should enrich financial SOE net assets with real fiscal spending, instead of relying on a circular process where MoF issues government bonds to state-owned banks and uses borrowed money to inject capital into financial SOEs
      • improving the corporate governance and professionalism of financial SOEs
  • local government debt risk, especially implicit, should not be transferred to the financial sector
    • government leverage ratio is artificially kept low as many implicit liabilities are excluded from the balance sheet
    • without clear state–market, financial–fiscal boundaries, excluding implicit debt from local governments only transfers risk to the finance sector
    • financial sector cannot control government behaviour in practice because
      • it cannot accurately assess risks due to obscure government budgeting
      • there is no local government bankruptcy scheme and the central government’s non-bailout promise is not tested, distorting financial market’s expectation, pricing and risk premiums
      • soft budget constraints make local governments insensitive about interest rates
    • the key to solving the local government debt problem is to accelerate fiscal reform, balance central–local relations, and build a marketised local government borrowing framework which will discipline local governments and make financial constraints effective