Budget 2012: Chinese Government to Implement "Structural Stimuli"

Deficit to Fall Further

Although the Chinese government has claimed that it will maintain a proactive fiscal policy stance this year, the budget has further tightened in absolute or relative terms. Central government fiscal deficit will be cut to CNY550 billion (USD86.8 billion), compared with the CNY700 billion target for 2011. Even though the local government deficit is raised to CNY250 billion, the combined deficit for the government sector—at CNY800 billion—still represents an about 11% cut from the 2011 target. In relative terms, the government deficit as a share of GDP will be nudged down to 1.5%, compared with about 2% in 2011. This will be the smallest government deficit/GDP ratio that China has reported since the global financial crisis.

Structural Stimuli

Clearly, fiscal proactiveness is not broad-based, but rather, narrow-based, targeting certain sectors. This has been reflected by the structural tax cut initiatives implemented this year, as well as increased spending in social welfare programmes. On the tax-cut front, the government is implementing a few tax-cut programmes initiated last year, which include the value-added tax (VAT) and business tax waivers for small and medium-sized enterprises (SMEs), replacement of business tax with VAT for the services sector in some piloting cities, as well as tax/fee cuts for logistics businesses.

On the spending front, the central government's spending plan has provided a clear roadmap on which sectors the government is trying to "stimulate". Social welfare spending remains the major gainer this year. Combined central government spending in sectors including medicare, education, social security and low-cost housing will hit 21.4% of total budget this year, compared with slightly over 20% realised last year.

One sector that has seen one of the biggest gains in budgeting support is low-cost housing. Total spending on low-cost housing as a share of central government expenditure will rise to 3.3%, up from 3.0% realised in 2011, making it the seventh biggest spending item for the central government this year. Low-cost housing construction new-start targets have been set at seven million units this year, down from last year's 10 million units, although total central government funding for the programme has increased with a larger stock of housing under construction. Another item that has received notable fiscal boost is education, as the Chinese government is trying to finally scale the milestone of having total government spending on education hit 4% of national GDP this year, a target first mentioned in 1993 but never fulfilled.

Infrastructure construction will remain largely on the sideline in 2012 with the scale-down in budget. Central government spending on the transport sector will decline to 5.6% of central government budget, from 5.8% reported last year. With the budget cut, government funds will be funnelled to the most needy infrastructure projects. Indeed, Premier Wen Jiabao had emphasised earlier in his work report that government funding will mainly support projects that are already under construction, which will avoid the emergence of a large number of half-completed projects that would inevitably lead to high non-performing loans. However, infrastructure spending in rural areas, focusing on water resource projects, shall pick up some of the slack of transport infrastructure, with spending in agricultural, forestry and water resource projects increasing slightly to 8.6% of total central budget this year, from 8.5% last year. Overall spending in the construction sector shall still hold up, with the aggregate share of low-cost housing, water resource projects, and transport spending actually increasing slightly from last year.

Outlook and Implications

The Chinese government has initiated an exit from the stimulus cycle in 2011, after a stunning stimulus cycle in 2009–10.But the stimulus exit strategy has faced challenges since mid-2011, with the escalation of the Eurozone crisis. With external risks heightened and governments' hands tied up by growing systemic fragilities arising after the stimulus cycle of 2009–10, the government has to work out a delicate balance between broad fiscal moderation—as reflected by the deficit/GDP ratio cut—and targeted fiscal stimuli—as indicated by the structural tax cuts and spending boosts. Such targeted stimuli should be sufficient to help the economy have a soft-landing this year, in a central case scenario where there is neither severe external shocks nor property market crash. In a low-probability scenario where there is severe shocks coming either domestically or externally, the government will have to move more aggressively, possibly pushing the deficit's share of GDP to 2–3% again.