By staff reporters Wang Changyong and Zhang Huanyu
From Caijing Magazine

China’s announcement of a 4 trillion yuan economic stimulus package lifted the markets in November, encouraging investors and winning support abroad.

But in recent weeks, many of the package’s rough edges have come to light, exposing the challenges facing central and local governments charged with implementing the two-year stimulus plan unveiled by the State Council.

One concern is that governments may need more time to raise the necessary cash. Adjustments to central and local government budgets must be approved by the National People’s Congress (NPC) or its local chapters. The central government’s stimulus spending is expected to be reviewed with its fourth quarter 2008 budget at a NPC Standing Committee meeting in late December, while 2009 a stimulus plan is to be discussed at an NPC convention in March.

While details of the massive investment plan inch through legislatures, the government’s top economic planners at the National Development and Reform Commission (NDRC) and the Ministry of Finance are busy debating funding sources and targets – the key details needed to breathe life into the much-anticipated package.

For example, NDRC Deputy Director Mu Hong said local governments must share the cost with central government investments. According to NDRC, local governments must provide 130 billion yuan and the central government 100 billion yuan in the fourth quarter 2008.

However, due to end-of-year budget constraints, local governments cannot be expected to dole out more than 30 billion yuan by the end of December, leaving a gap of 100 billion yuan. And over the next two years, local governments will have to come up with another 1.25 trillion yuan.

Meanwhile, local governments are pessimistic about future revenues. They face shrinking taxes and land sale income due to the economic downturn. NDRC estimated all local governments nationwide may be able to invest no more than 620 billion yuan for the stimulus initiative – at least 500 billion yuan less than Beijing planned.

Bonds versus Loans

To help local governments, NDRC is considering two options. The central government may increase its own investment share while reducing or waiving requirements for the locals. Under another scenario, the central government would finance projects via onward lending.

Onward lending was used by the central government between 1998 and 2004 to finance local projects. Beijing raised 108 billion yuan by issuing bonds and loaned 58 billion yuan to local governments at interest rates above the bond rates. These one-year loans were not included in government budgets.

If the central government resorts to onward lending to close the stimulus investment gap with local governments, bonds worth 600 billion yuan would have to be issued. These would be included in the total 1.78 trillion yuan in stimulus-related bonds that would have to be issued by 2010.

So far, the central government has only sought matching investments from local governments. But Beijing is expected to encourage state commercial bank investments for projects that focus on promoting investment and domestic consumption.

Although NDRC favors the onward lending approach, its stimulus package partners at the Ministry of Finance are more concerned about the possibility of fiscal deficits in coming years.

The economic downturn has slowed the growth of government revenues. Pressure is expected to increase next year due to changes in value-added taxes and tax rebates. Deputy Finance Minister Wang Jun estimates central government tax revenues will fall by 300 billion yuan next year.

Against this backdrop, the finance ministry has asked the State Council to let local governments issue bonds, with a view to reducing the central government’s risks and burdens.

The ministry fears a repeat of its past experiences with local governments, many of which simply failed to repay loans issued through onward lending programs, forcing Beijing to write off debts. Fueling this concern is that some investment priorities in the stimulus package – including low-income housing, rural infrastructure construction, and school construction in western regions – would not be profitable.

But NDRC questions the feasibility of local government bonds. “The conditions for allowing local governments to issue bonds still do not exist in China,” said Xu Lin, NDRC finance director.

China’s Budget Law requires local governments to balance accounts, with no deficits.

For the central government, the big question for 09’ is how large the deficit would be. At the beginning of 2008,  target deficit was set at the 180 billion level, which might be tested by the newly added spending -- investment of 100 billion in the fourth quarter to spur the economy and 20 billion yuan reconstruction fund for disaster-stricken areas.

Budget officials told Caijing that funds from two channels can fill in the hole. First, the central government has a budget stability fund of 40 billion. And central government revenue usually has a surplus, providing extra cash for the policymakers. This year’s revenue is expected to be 400-500 billion more than planned, and 300 billion will be pocketed by the central government and used to foot the new bills

China might expect a sharp deficit rise in order to stimulate the economy, although the central government bonds are not included.  The shortfall could hit 500 billion yuan in 2009 from this year’s targeted 180 billion.

Stimulus Targets

The stimulus package calls for spending in 10 major areas, including affordable housing, rural infrastructure, water and power projects, transportation, environmental improvement, technological innovation and rebuilding from natural disasters. The plan favors traditional growth areas, prioritizing infrastructure over public services.

NDRC decided the first round of the initiative would be launched in the country’s south. “Most of the projects we have chosen are in the country’s south,” a commission official said. “It’s now too cold to start construction in the north.”

The government said it would give priority to “maintaining steady and relatively fast growth” in 2009, with “positive” fiscal and “moderately relaxed” monetary policies, abandoning earlier tight monetary policies aimed at controlling inflation. In addition, a new value-added tax and other tax changes would roll out across the country next year.

China’s leaders were influenced by a worsening economy, which turned down more rapidly than expected, especially in coastal areas. Premier Wen Jiabao called for attacking the crisis with “a fast and heavy fist, accurate steps and forceful delivery.”

Some stimulus items were on the government’s agenda before the November announcement. “Many of the projects were previously on our agenda,” said NDRC Deputy Secretary Ma Liqiang. But he added the decision accelerated implementation plans; some long-term projects were moved up to next year’s agenda.

Analysts say the stimulus plan should tide the Chinese economy over. Despite economic uncertainties in other countries, heavy investment should allow China’s economy to grow at a rate of more than 8 percent in 2009.

Chen Xingdong, chief economist at Paris Bourse (Asia) Co. Ltd., said if China wants to maintain an 8 to 9 percent growth rate, the government’s macroeconomic policies will have to contribute to two to 2.5 percentage points because domestic consumption can power a growth rate of no more than 5.5 to 6.5 percent. 

According to Shen Minggao, Caijing’s chief economist, the Chinese economy will see growth of 8.5 percent in 2009 if the stimulus initiatives are implemented. This view is echoed by Gao Shanwen, chief economist at Essence Securities, who predicts the government initiatives will push up GDP by three percentage points.

But Gao called the package “too late and too much.”

“The government should have anticipated the speedy downturn of the economy,” he said. “When it failed to do so, it lost the opportunity to take the initiative.”

And the stimulus alone is not expected to solve all China’s economic woes. The world’s economy is deteriorating, weakening demand for Chinese exports. And although many experts have called for China to encourage domestic spending, consumption-targeted programs represent only a small portion of the stimulus package.

An overwhelming number of projects are aimed at promoting investment and exports. Credit lending programs favor farmers and low-income groups. But urban consumers are not expected to get the income tax rebates that some say could spur consumption.

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