By Xi Si (席斯), Cheng Zhiyun (程志云) and Du Yan (杜艷)
Issue 342, Nov 19, 2007
News, cover
Translated by Lam Li
Original Article: [Chinese]

The call for giving priority to fiscal rather than monetary policy in China is gathering momentum as economists anticipate a slower growth for the country in coming years.

Although the Chinese economy has experienced years of high growth rates, concerns are growing over excess liquidity, a bubbling stock market, overheating real estate prices, and climbing inflation.

Debate on what policy would best curb the threats is fierce among market watchers and academics, with some supporters of monetary policy – which has become the mainstay of China's macro-economy toolkit in recent years – now turning their favor to a fiscal approach.

One of them is Standard Chartered senior China economist Stephen Green, who in his recent Asia Focus report projected a slower growth for China after mid-2008, adding that fiscal policy would become more prominent.

Of late, Green – who is held as an expert in monetary policy analysis – has been busy meeting and exchanging views with government officials, academics and journalists focusing on the fiscal approach.

He justifies his recent change of direction by saying: "The fiscal side has not been important for growth, which is what we normally focus on as bank economists. Going forward, once the economy slows and other liabilities (like pensions) show up more clearly in the system, the government's fiscal situation will become more important."

He adds, "If the economy slows, naturally, or via tighter monetary and foreign currency policy, then more stimulative fiscal policy could support growth."

To Green, the big questions though are whether fiscal spending can really be increased significantly for education and healthcare, and if such spending could support near-term growth.

Another economist who has called for better fiscal policy is Yu Yongding, director of International Economy and Politics Research Center under the Chinese Academy of Social Sciences.

Yu has written extensively on the importance of fiscal plans in supplementing monetary policy to curb a bubble economy and to alleviate the pressure of currency appreciation.

China International Capital Corporation's macro-economy analyst Xing Zhiqiang also echoes that view: "We strongly support and encourage the expansion of fiscal applications, and moving away from over dependency on monetary policy, which is ineffective in curbing an overheated economy and trade surplus-related problems."

Historical Rivalry between Monetary and Fiscal
For the past decades in China, the emphasis on monetary or fiscal policy has swapped priority several times. Between 1993 and 1998, the government had applied the two policies simultaneously for a soft landing in view of a prolong overheating economy.

In 1998, in the fallout of the Asian financial crisis, the Chinese government had first put forward monetary policy. Then, the interest rate was cut three times to an all time low of 1.98%, but consumption and retail prices remained in negative growth.

The failure to boost growth had later led the Chinese government to turn to fiscal policy as a remedy, recalls Researcher Ma Caichen from Institute of Finance and Trade Economics under the Chinese Academy of Social Sciences. Ma explains: "Back in those days, the two policies were introduced in sequence, one after another."

Between late 1990s and early 2000s, China issued state bonds totaling to 600 billion yuan, and at the same time, government spending was enlarged so much that its budget was in the red. By 2002, the government deficit had increased to 3% and inflation was pressing, the backlashes triggered calls to abandon fiscal policy from economists.

Subsequently, monetary policy emerged as the mainstream in macro-economy control tool, as fiscal approach faded into the background under mounted pressure from inflation.

In 2004, a planned tax reform involving the introduction of a value-added tax and rate cut was shelved, as the government feared the already inflated investment market would worsen under such fiscal pressure.

While the government has hesitated in introducing fiscal policy, it has wielded the monetary tool at length. Between 2004 and October this year, the Central Bank has increased interest rates nine times (five in this year alone) and also expanded the reserve ratio nine times during the same period.

However, such measures have yet to resolve or slow the trend of excess liquidity, to temper the huge trade surplus, or to damper climbing asset prices. Based on economic data in October, the consumer price index has reached an all time high of 6.5%, and there is no sign of a narrowing trade surplus.

As the Chinese government's reserve ratio has reached new height while the Federal Reserves of the United States has lowered its interest rates, the interest gap between China and America is reducing, thus, leaving less room for maneuvering of monetary policy in China.

Ma Caichen explains that China only has two cards in its macro-economic hand– monetary and fiscal – and when the earlier failed, it is natural for higher expectations to be placed on the latter.

Ways to Play the Fiscal Card
Citic Securities analyst Chen Jiju believes that the government has started testing the water with fiscal tool this year, including the introduction of rebate for export tax and issuance of special state bonds.

One fiscal strategy that was deemed effective this year is raising the stamp duty from 1% to 3% on May 30th. After the policy was announced, stock exchange indexes in Shanghai and Shenzhen dropped drastically; 281 and 829 points respectively.

Institute of Finance and Trade Economics researcher Yang Zhiyong points out that numerous recent interest rate cuts and bank reserve hikes have failed to shake the stock market, but two weeks ago, an announcement of the Resources Tax adjustments had caused an overall drop in share prices for resources-related industry.

Another researcher from the institute, Ma Caichen adds that monetary policy is dependent on the market economy system to materialize its objectives, thus, its impact is indirect; whereas fiscal policy is a direct involvement of the government, so its impact is straightforward.

A source from the China Banking Regulatory Commission agrees that fiscal strategies are needed to balance the many uncertainties emerging in the Chinese economy today, adding that one of the major tasks is to curb hot money and overheating investment. That said, the source also cautions government against spending on direct investment.

China Galaxy Securities chief economist Zuo Xiaolei believes that there will be changes in fiscal policy next year but the aim is not directed at stimulating economic growth. She thinks the expected fiscal policy via tax adjustments is a step towards fine-tuning the relationships between Central and local governments through a re-distribution of resources.

Ministry of Commerce's Policy Research Department released a report recently suggesting a global economy downswing next year could be the biggest challenge facing China. The report cautions that if exports dropped drastically, the upwards trend of economic growth may finally come to a head.

Says one source from the China Banking Regulatory Commission, under such circumstances, it would be high time to play both cards at once to cushion any economic decline.