China Budget Revision Would Mark ‘Sea Change’ in Fiscal Strategy

A rare mid-year revision to China’s budget to juice the recovery with more stimulus would signal that top leaders are moving away from a growth model that is piling ever more debt on local governments.

(Bloomberg) — A rare mid-year revision to China’s budget to juice the recovery with more stimulus would signal that top leaders are moving away from a growth model that is piling ever more debt on local governments.

That’s the verdict among economists after people familiar with the matter said that policymakers are considering raising the budget deficit for 2023 by issuing at least 1 trillion yuan ($137 billion) in sovereign debt for infrastructure spending — an amount that would push the deficit to well above the 3% cap set in March. 

“It’s a big deal that Beijing is thinking of funding this itself,” said Dinny McMahon, head of China markets research at consultancy Trivium China. “This would be an implicit acknowledgment by Beijing that the traditional model of funding infrastructure is broken.”

China has for years been loading debt on the balance sheets of local governments and companies they own to fund infrastructure spending — a key growth driver for the world’s second-largest economy. Putting more of the fiscal burden on the central government would underscore President Xi Jinping’s need to counter an economic slowdown, while also highlighting growing concern among authorities that indebted local governments are running out of room to leverage up.

The Chinese government usually tries to make sure its headline budget deficit never exceeds 3% of gross domestic product. So rare is the landmark proposal to revise the budget in the middle of the year that it’s only been done a handful of times during emergencies, such as in the aftermath of the 2008 earthquake in Sichuan province and the 1998 Asian Financial Crisis.

A move beyond the usual debt-to-GDP target “could show a greater sense of urgency of the policymakers” as they push to meet a goal of about 5% economic growth in 2023, according to Citigroup Inc. economists led by Yu Xiangrong.

What Bloomberg’s Economists Say … 

“If this plan materializes we think it will undoubtedly boost confidence and raise the probability of the nation achieving its 5% growth target. It will also signal that senior leaders are serious about stabilizing the economy — they’ve noticed the constraints local governments face in delivering fiscal stimulus — and are willing to adopt more flexible methods to do so.”

— David Qu and Eric Zhu, economists

Read the full report here. 

Chinese stocks gained on Wednesday, with the Hang Seng China Enterprises Index rising as much as 2.1% while the onshore benchmark CSI 300 Index rose as much as 0.9% to halt two days of losses. Still, traders remain skeptical about a sustainable rebound in equities, given previous rallies have faded.

“The news can help sentiment but the impact will fade, even if it materializes, as investors will think it isn’t enough,” said Redmond Wong, a market strategist at Saxo Capital Markets in Hong Kong.

Sea Change

What makes this time different is that the economy isn’t facing a sudden blow to growth. While some activity has slowed in recent months, the rate of expansion is still accelerating relative to Covid lockdown-hit 2022. Economists broadly expect China to just about match its growth goal for the year. 

That may make the issuance of additional central government debt less of an emergency response and more an admission of a major structural problem with local government borrowing.

“The big question is whether Beijing will take on the majority of the burden of infrastructure investment next year and the year after,” McMahon said. “If so, this could signal a sea change in how Beijing and local governments share fiscal responsibilities.”

Infrastructure investment has been expanding rapidly this year on the back of continued local government borrowing and strong central government outlays on rail and power projects. That’s partially offset the decline in the construction of new properties as developers suffer from liquidity strains and people hold off on buying homes. 

Even so, the property sector remains a major drag on the economy. Home sales haven’t really improved, and many economists predict the housing market could take up to a year to stabilize. 

The real estate slump has also exposed limitations within the local government debt model, with the crisis reducing their ability to service debt, while also cutting fiscal outlays on the preparation of land those regional authorities sell to developers — itself a key form of infrastructure investment. 

All About Timing 

The budget revision is not yet a done deal. Deliberations are ongoing and the government’s plans could change, one person familiar with the matter told Bloomberg News. It would also need to be approved by the Standing Committee of the National People’s Congress — the Communist Party-controlled legislature — which is expected to meet at the end of the month. 

That process could slow the amount of time it takes to approve bonds, leaving economists in disagreement about when the money would be spent and how long it may take before any effects may be seen. 

Trivium’s McMahon and the Citi economists see the plan as able to support spending in November and December, thus aiding growth for 2023. 

Winter weather conditions may limit how much progress can be made on infrastructure projects, the Citi economists wrote in a research note. “The window for action could be rather short, which may translate into a much stronger fiscal impulse within a short period of time.”

Others see the impact as more relevant for next year. 

“It takes time from bond issuance to spending the proceeds,” said Neo Wang, Evercore ISI’s New York-based managing director for China research. “Therefore, it is more likely aimed at getting things ready for a strong start in 2024.”

Beijing’s Resolve

Beijing has shown increasing resolve to aid local governments with fiscal problems.: Last month, it kicked off a 1 trillion yuan-program to allow struggling regional authorities to swap high-interest borrowing  for lower-interest bonds.

The proposal under consideration would “indicate stronger sincerity in Beijing to resolve the local debt issue, consistent with moves recently around refinancing bonds,” Wang said. 

Focusing on infrastructure may also signal that Beijing doesn’t expect a quick recovery for the housing market. 

“We don’t think Beijing would be comfortable to go too far on housing stimulus,” Wang said, adding that housing floor space under construction is expected to continue falling. “Job losses will continue from housing construction, making sense for more infrastructure stimulus.”

Others are skeptical that Beijing will follow through on a budget revision at all. 

The government is more likely to use other approaches toward raising funding “with less political and institutional obstacles,” Goldman Sachs Group Inc. economists including Lisheng Wang wrote in a note. That could include tapping unspent government bond quota, stepping up policy bank financing support or pre-approving some bond issuance from next year’s budget.

Authorities are weighing other options aside from infrastructure spending, according to people familiar with the matter. That may include boosting consumption through subsidizing medical care expenses in rural areas, one of the people said. 

Beijing is more likely to tap part of the around 1 trillion yuan worth of unused bond issuance that had been budgeted for previous years, according to Houze Song, a fellow at the Paulson Institute. That would add fiscal support while staying within the current budget.

“I think stimulus decision is more related to Beijing’s thinking on 2024 growth,” Song said. “If indeed Beijing chooses to stimulate, it means we need to revise up the 2024 growth target to around 5%.”

–With assistance from Xiao Zibang, Zhu Lin and Zhang Dingmin.

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