Abstract
Selected Issues
Reassessing the Perimeter of Government and Implications for Fiscal Space1
Broader definitions of government continue to be relevant. While progress has been made in reducing existing avenues for off-budget fiscal spending, new avenues have emerged.
China has some fiscal space for temporary fiscal expansions, but it is constrained.
Further improvements to the fiscal framework are needed to bring all local government infrastructure spending on budget.
A. Broader Definitions of Government Deficit/Debt Remain Relevant
1. Since 2014, the authorities took significant measures to expand on-budget deficits and debt (“open the front door”) while limiting off-budget activities (“close the back door”). The authorities issued several important documents, namely:
New budget law (August 2014), effective in January 2015 sets out broad goals.2
State Council document 43 (September 2014) operationalizes the new budget law.3
State Council document 88 (November 2016) creates a resolution framework that categorizes Local Government (LG) units by risk level and sets corrective measures.
Joint circular 50 (April 2017) tightens the ban on off-budget borrowing and urges local governments to inspect thoroughly financing activities and correct illegal behavior by July 2017.
2. The front door opened and on-budget LG deficits and debt expanded. LG on budget net borrowing rose from 0.3 percent of GDP in 2014 to 2.4 percent in 2016,4 and, in the same period, LG bond issuance expanded from 0.5 to 1.2 percent of GDP. In 2014, the government brought on-budget a large stock of local government financing vehicle (LGFV) debt of around 22 percent of GDP, and initiated a swap for new LG bonds. The swap is progressing and is to be completed by 2018.
3. Despite the considerable efforts, a back door remains open through three main channels:
First, LGFVs borrowed extensively in 2016 and market perceptions of their implicit guarantee do not seem to have changed substantially since the new budget law, though this could be changing with the recent tightening of financial conditions. In the onshore market, LGFV bond spreads declined continuously up to Nov-2016, even after the new budget law was implemented. In the offshore market, international rating agencies continue to factor-in government support in LGFV ratings. However, since late 2016, financial conditions in onshore markets have tightened considerably. LGFVs have seen decreased issuance and higher spreads, particularly for lower-rated LGFVs. This could be an indication that perceptions are beginning to change, although LGFV yields receded slightly in April-May and thus it is still too early to judge.
Second, PPPs are meant to replace the LGFV model but the difference may be only superficial. Although PPPs are meant to substitute the LGFV model by utilizing financing from and shifting risk to the private sector, most PPPs are concentrated in traditional public infrastructure areas (more than 80 percent) and the PPP partner is often state-controlled (solely private partners make up around 30 percent of investment). Partners can range from policy banks, government funds, private capital to other state-owned parties, like central and local SOEs and even LGFVs. The capital value of planned PPP projects is significant at 27 percent of GDP by end-2016, with 1/5 under implementation.
Third, the authorities are increasingly setting up Government Guided Funds (GGFs) and Special Construction Funds (SCFs) to fund public infrastructure. These new financing vehicles are akin to public venture capital funds which are unusual in an international context. GGFs are funded by a mixture of budgetary (a “junior tranche”) and non-budgetary financing (a “senior tranche” delivering a steady return) called “social capital”, which includes SOEs, LGFVs, banks or other financial institutions. SCFs are entirely funded by policy banks. GGFs and SCFs are still raising capital, with end-2016 assets of around 5 percent of GDP. Detailed information on their activities is not available, but these funds are likely investing in equity stakes of PPPs or firms, and also lending.
Bond spreads over treasury bonds at 5 year tenor
(percentage points)
Citation: IMF Staff Country Reports 2017, 248; 10.5089/9781484314722.002.A007
1/ Secondary market. Sources: WIND, CEIC, staff estimates.Bond spreads over treasury bonds at 5 year tenor
(percentage points)
Citation: IMF Staff Country Reports 2017, 248; 10.5089/9781484314722.002.A007
1/ Secondary market. Sources: WIND, CEIC, staff estimates.Bond spreads over treasury bonds at 5 year tenor
(percentage points)
Citation: IMF Staff Country Reports 2017, 248; 10.5089/9781484314722.002.A007
1/ Secondary market. Sources: WIND, CEIC, staff estimates.
New ways to fund infrastructure
Citation: IMF Staff Country Reports 2017, 248; 10.5089/9781484314722.002.A007
New ways to fund infrastructure
Citation: IMF Staff Country Reports 2017, 248; 10.5089/9781484314722.002.A007
New ways to fund infrastructure
Citation: IMF Staff Country Reports 2017, 248; 10.5089/9781484314722.002.A007
4. Given the quasi-fiscal nature of these three channels, the concept of augmented fiscal aggregates not only remains relevant but an expansion of its perimeter is warranted. In the past, a large part of fiscal stimulus occurred off-budget through LGFVs5, prompting the creation of the concept of “augmented” balance and “augmented” debt.6 Staff judges that LGFVs continue to mostly operate as quasi-fiscal units (in GFSM terms, “public non-market producers”, see Box 1) and thus their activities will continue to be included in estimates of augmented balance and debt. In addition:
There is a strong case for including government funds in augmented fiscal accounts. Following the guidelines for sector classification in the Government Finance Statistics Manual GFSM 2014, staff concludes that these funds are likely to be general government units based on government control and non-market nature of their activities (Box 1).
While, some of China’s PPPs should in principle be recorded on-balance sheet7, estimates are highly uncertain. Including government-funded PPPs expands the augmented balance (Augmented ++) only marginally as most PPPs are yet to be implemented. These estimates are very uncertain due to insufficient granularity of published data on PPPs.
5. Considering the tradeoffs, staff included GGFs and SCFs in augmented aggregates (“augmented+”) and finds that China’s fiscal stance is more expansionary than previously thought. China’s “augmented+” deficit reached 12.4 percent of GDP in 2016 from 9.8 in 2014. Under the previous definition of augmented balance (including only LGFVs), the deficit expanded only marginally to 10.3 in the same period (text chart). Given the uncertainties regarding PPPs, staff is not including those for now in its preferred definition of the augmented deficit/debt (“Augmented +”). PPPs may be included in the future depending on data availability.
Augmented government balance: different definitions
(In percent of GDP)
Citation: IMF Staff Country Reports 2017, 248; 10.5089/9781484314722.002.A007
1/ Including only LGFV activity. 2/ Adding SCF and GGF. 3/ Adding govt funded PPPs.Sources: CEIC, Chinese Authorities, news sources, and staff estimates.Augmented government balance: different definitions
(In percent of GDP)
Citation: IMF Staff Country Reports 2017, 248; 10.5089/9781484314722.002.A007
1/ Including only LGFV activity. 2/ Adding SCF and GGF. 3/ Adding govt funded PPPs.Sources: CEIC, Chinese Authorities, news sources, and staff estimates.Augmented government balance: different definitions
(In percent of GDP)
Citation: IMF Staff Country Reports 2017, 248; 10.5089/9781484314722.002.A007
1/ Including only LGFV activity. 2/ Adding SCF and GGF. 3/ Adding govt funded PPPs.Sources: CEIC, Chinese Authorities, news sources, and staff estimates.6. Even after expanding the perimeter of augmented aggregates, all of the expansion of China’s fiscal stance in 2014–16 was on-budget. On-budget net borrowing expanded by 2¾ percent of GDP in 2014–2016, meaning off-budget activities are estimated to have remained broadly unchanged after expanding the perimeter of augmented aggregates.
Treatment of Quasi-fiscal Units in Government Finance Statistics Manual (GFSM) 2014
GFSM 2014 classification. Chapter 2 of the IMF’s GFSM 2014 classifies entities based on whether they are public or private sector units. Classification inside the public sector is based on the principle of control and GFSM 2014 Box 2.2 provides eight indicators to judge government control. Within the public sector, units can be classified as market or non-market based on the nature of their activities. Public non-market producers should be included in government whereas public market producers are classified outside government as public corporations. GFSM 2014 2.69–75 defines a test for classifying public units as market producers in which operating revenues must exceed 50 percent of production costs.1 Even entities classified outside of government can have part of their activities reflected in government accounts, if acting on behalf of or under the instruction of government (under GFSM 2014 3.28 on rerouting).
Treatment of SCFs and GGFs. These funds should be regarded as public sector units since the government – National Development and Reform Commission, Ministry of Finance or local governments – retains control (even if the government is a minority shareholder2). These funds are akin to venture capital funds, but do not appear to make market-based decisions in exclusive pursuit of commercial returns. Thus, staff concludes they should be included in government. The treatment of social capital contributions as debt is based on GFSM 2014 7.143, 7.150 and 7.166.
Perimeter of government in IMF surveillance. IMF surveillance frequently extends the coverage of fiscal data to include parts of the wider public sector. Examples of this practice are: (i) Brazil (data includes the Central Bank and some public nonfinancial enterprises), (ii) Mexico (data covers state owned enterprises and development banks), and (iii) Mongolia (data covers the development bank). Moreover, many countries, particularly in the E.U., already use a definition of general government consistent with GFSM and thus the perimeter of general government goes well beyond budgetary units.
1 Eurostat’s Manual on Government Deficit and Debt section I.2.4.3 further elaborates on this test.2 Interim Measures for the administration of government investment funds (November 2015), Ministry of Finance.B. China Has Some Fiscal Space, But Less Than Headline Debt Figures Suggest
7. Narrowly-defined government debt is moderate compared to other Emerging Market Economies (“EME”). Narrowly-defined government debt8 was 37 percent of GDP by end-2016, below the median EME of 48 percent of GDP. Broadly defined debt9 (Augmented+) is larger at around 62 percent of GDP.
8. Other indicators for assessing fiscal space also look favorable except for elevated gross financing needs. Financing is readily available and at low cost, due to high domestic savings. Participation of foreigners in the domestic sovereign bond market is still limited and economy-wide external financing requirements are manageable at around 7 percent of GDP. Gross financing needs are projected to stay elevated at above 12 percent of GDP both in 2017 and 2018.
9. China has some fiscal space under the narrow definition of government, but less under the augmented definition
Narrow definition of deficit/debt. If fiscal space is defined as the ability to use fiscal policy temporarily to smoothen the cycle without losing market access, China certainly has space10, which could be used to support the reform process if limited in time to avoid even faster debt accumulation. But taking a broader view of fiscal space, permanent fiscal expansions can be accommodated only if higher levels of debt are tolerated: a permanent 0.9 p.p. of GDP expansion over the 2016 primary balance stabilizes debt at around 100 percent of GDP (75th percentile of AEs’ debt-to-GDP). China could likely tolerate significantly higher levels of government debt than almost all EMs due to high savings, strong external position, capital controls, strong state control and confidence
“Augmented” definition of deficit/debt. Under the “augmented” definition of debt/deficit, China would only have very limited space for a temporary loosening, and negative space for a permanent expansion. Staff estimates broadly defined (“Augmented+”) government debt to be around 62 percent of GDP in 2016, rising to 92 percent of GDP in 2022, substantially above the current 75th percentile and closer to the 75th percentile of AEs. Indeed, under the augmented definition, the primary balance needs to be improved by 4 percentage points of GDP by 2022 to stabilize augmented debt at around 100 percent of GDP.
Debt stabilizing primary deficit
(percent of GDP)
Citation: IMF Staff Country Reports 2017, 248; 10.5089/9781484314722.002.A007
Note: Calculations take into account non-debt creating financing from land sales.Debt stabilizing primary deficit
(percent of GDP)
Citation: IMF Staff Country Reports 2017, 248; 10.5089/9781484314722.002.A007
Note: Calculations take into account non-debt creating financing from land sales.Debt stabilizing primary deficit
(percent of GDP)
Citation: IMF Staff Country Reports 2017, 248; 10.5089/9781484314722.002.A007
Note: Calculations take into account non-debt creating financing from land sales.10. However, China’s debt dynamics look significantly worse after accounting for a higher structural balance due to ageing. Ageing could increase the yearly structural deficit by an average of 2.5 percent of GDP under current policies until 2050.11 Applying this increase to China’s projected primary balance after 2017 leads to government debt under the narrow definition of 57 percent of GDP in 2022 compared to 42 percent without this adjustment. The 2022 primary balance is nearly 3 percentage points higher than its debt stabilizing level.
11. Furthermore, fiscal space is also constrained by potential fiscal losses with implicit guarantees. Under the DSA’s stylized contingent liability shock of 10 percent of bank claims against non-public entities, China’s debt reaches 69 percent of GDP in 2022, compared to 42 percent of GDP (narrow definition) without this shock, and does not stabilize.
12. Finally, if the economy faces a negative shock and fiscal policy needs to be used, the required stimulus should promote rebalancing and not investment Box 2).
If Needed, Fiscal Stimulus Should Promote Rebalancing and Not Increase Investment1
We estimate the size of the fiscal stimulus needed to bring growth back to baseline under a mild temporary shock, and a larger protracted shock. Because the GDP response depends on the fiscal stimulus composition, we consider two different packages:
• one based entirely on scaling up investment. We assume that the output multiplier decreases the more investment exceeds baseline levels (Maliszewski et al. 2016, and Bai et al. 2016).
• one based on rebalancing measures. As these measures cannot be scaled up indefinitely, we cap revenue and spending measures to 2 and 1 percent of GDP respectively, and assume that any additional stimulus needed to reach baseline growth would come from investment.
Under a temporary mild shock the two packages would roughly have the same size; but if the shock is large and protracted, a very large amount of investment would be needed to lift GDP back to baseline, owing to diminishing multiplier. Instead, a smaller package of rebalancing measures would be sufficient, and have a smaller impact on debt.
Size of stimulus with small shock
Citation: IMF Staff Country Reports 2017, 248; 10.5089/9781484314722.002.A007
Size of stimulus with small shock
Citation: IMF Staff Country Reports 2017, 248; 10.5089/9781484314722.002.A007
Size of stimulus with small shock
Citation: IMF Staff Country Reports 2017, 248; 10.5089/9781484314722.002.A007
Size of stimulus with large shock
Citation: IMF Staff Country Reports 2017, 248; 10.5089/9781484314722.002.A007
Size of stimulus with large shock
Citation: IMF Staff Country Reports 2017, 248; 10.5089/9781484314722.002.A007
Size of stimulus with large shock
Citation: IMF Staff Country Reports 2017, 248; 10.5089/9781484314722.002.A007
Increase in debt in 2022, relative to baseline
Citation: IMF Staff Country Reports 2017, 248; 10.5089/9781484314722.002.A007
Increase in debt in 2022, relative to baseline
Citation: IMF Staff Country Reports 2017, 248; 10.5089/9781484314722.002.A007
Increase in debt in 2022, relative to baseline
Citation: IMF Staff Country Reports 2017, 248; 10.5089/9781484314722.002.A007
C. Policy Implications
13. The authorities have taken important steps to stem off-budget borrowing in the last two years. They have intensified their efforts to control off-budget activities and have achieved some progress. Several laws and regulations have been issued and enforcement actions are being stepped up.
14. But having all LG infrastructure spending on-budget requires substantial further improvement of the fiscal framework. Key areas:
Planning: Formulate a medium-term fiscal framework, including a medium-term integrated capital financing, that includes all LG infrastructure spending. Create an incentive system for LG units using a combination of carrots (higher bond quotas, expedited approval of infrastructure projects) and sticks (enforcement, legal actions)
Monitoring: Increase capacity and resources at the provincial government level for effective monitoring of lower level units. Crucially, enlarge the perimeter of monitoring.
Transparency: The authorities should publish detailed and easily accessible budget accounts and overall debt levels by province at least yearly, including contingent liabilities by type. Medium-term fiscal projections and an assessment of the riskiness of broadly defined public debt by province or even district could also be published regularly.
References
Bai, Chong-En, Chang-Tai Hsieh, and Zheng Michael Song, 2016, “The Long Shadow of a Fiscal Expansion”, NBER Working Paper 22801.
IMF, 2017, “Modernizing China: Investing in soft infrastructure”, edited by R. Lam, M. Rodlauer, and A. Schipke.
Maliszewski, Wojciech, Serkan Arslanalp, John Caparusso, José Garrido, Si Guo, Joong Shik Kang, W. Raphael Lam, T. Daniel Law, Wei Liao, Nadia Rendak, Philippe Wingender, Jiangyan Yu, and Longmei Zhang, 2016, “Resolving China’s Corporate Debt Problem”, IMF Working Paper 16/203.
Zhang and Barnett, 2014, IMF WP
See IMF (2017) for a thorough discussion of the budget law.
The initial thrust was somewhat scaled back when Document 43 was amended in May 2015.
After deducting central government transfers and land sales revenue but before bond/cash financing.
See Bai and others (2016) for a comprehensive discussion of the off-budget stimulus undertaken in 2009–10.
See Zhang and Barnett (2014) for the original estimates and discussion.
See GFSM 2014 Appendix 4, paragraphs A4.58–65 and IPSAS 32 on “Service Concession Arrangements”.
Official on-budget general government debt.
Adds remaining LGFV debt and SCF and GGF government liabilities to general government debt.
Analysis of fiscal space makes use of current fiscal indicators as well as stress tests from the IMF’s Debt Sustainability Analysis (DSA) and simulations using the IMF’s Flexible System of Global Models (FSGM).
Calculated as the constant equivalent flow of additional health and pension expenditures under the UN medium-variant population projections against a baseline of constant population for the period of 2015–2050. This roughly corresponds to an additional liability of around 90 percent of 2015 GDP in present value terms.
