Caixin
Dec 21, 2016 11:10 AM
ECONOMY

Nation's Fiscal Deficit Could See Increase Next Year, Analysts Say

(Beijing) — China's fiscal deficit may rise next year as Beijing is expected to cut taxes and increase infrastructure investment to drive growth, analysts said as they examined likely economic and policy scenarios for 2017.

Meanwhile, the government needs to trim unnecessary, even harmful, subsidies such as those impeding competition in order to improve the efficiency of its spending, they said.

Fiscal policy is set to play a bigger role in 2017 in supporting growth because the government is worried that monetary loosening could fuel capital outflows and add depreciation pressure on the Chinese currency, making yuan-denominated assets less attractive.

"Fiscal policy must be more active and efficient, and budget priorities must facilitate supply-side reforms, reduce companies' tax burdens and ensure basic spending on the social safety net," according to a government statement issued after top leaders ended the three-day Central Economic Work Conference on Friday.

The annual meeting, presided over by President Xi Jinping, is closely watched because the leaders set the agenda for economic policy in the coming year.

Among the changes that analysts expect to see are the following:

More infrastructure investment, a higher fiscal deficit

The property market's boost to the economy will become unsustainable next year, as many local authorities tightened purchase restrictions to rein in mortgage risks and appease public anger over runaway prices. That means the government must invest more in infrastructure construction to maintain growth.

"Increasing infrastructure investment through an expansionary fiscal policy is not the best option for the future. But we have no better choice," said Yu Yongding, a senior researcher with the Chinese Academy of Social Sciences, a government think tank.

Beijing budgeted 2.18 trillion yuan ($313 billion) in deficits for 2016, or 3% of gross domestic product (GDP), up from 2.3% in 2015.

A number of economists are forecasting the ratio to continue to rise next year to 3.2% to 3.5% depending on the GDP growth rate that Beijing targets.

Deficits will increase "mainly to compensate for revenue shortfalls led by tax cuts and to ensure payments of government obligations," said Zhu Baoliang, an economist with the State Information Center, which is linked to the National Development and Reform Commission, the country's top economic-planning agency.

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He predicted the budget deficit will jump to 3.5% of GDP to maintain economic growth rate at 6.5%.

Slowing revenue growth

Zhong Zhengsheng, director of macroeconomic analysis at CEBM Group, a subsidiary of Caixin Insight Group, estimated that property investment will fall 2 percentage points next year and infrastructure investment must soar by around 5 percentage points to over 20% to make up that loss.

Such an increase will create a huge demand for cash. Experts believed it will force the government to take on more debt because increases in fiscal revenues in recent years have been slower not only than fiscal spending gains but also than economic growth rates.

The government recorded 14.83 trillion yuan in revenues during the first 11 months of the year, up 5.7 percent year on year, while its expenditures jumped 10.2% in the period to 16.58 trillion yuan. The GDP rose 6.7 percent in the first three quarters of the year, latest official figures showed.

"The efficacy of the active fiscal policy depends on whether local fiscal policy can expand with the central fiscal policy at the same pace," said Niu Bokun, an economist with Huachuang Securities, adding some local authorities' financing may be strained.

More regulated financing

Special construction funds have been a key driver of infrastructure investment since the second half of last year, analysts said.

The funds were raised through bonds issued since August 2015 by policy lenders China Development Bank Corp. and the Agricultural Development Bank of China to commercial banks, and were invested as equity stakes in construction projects.

But the low-cost arrangement, whose interest was mostly subsidized by the government, became risky because the funds were often used as capital to borrow even more money, increasing debt levels, experts said.

They predicted regulations on the funds could become stricter, sometimes reducing subsidies to bring costs up so that funds would be used more prudently. Or they could be replaced by more transparent and controllable treasury bonds.

"Special construction funds are an emergency policy and cannot be used for the long term. The bond issuance must be stopped once the economy stabilizes," Zhu said.

The government would "rather increase debt through more transparent ways such as a rise in fiscal deficit than through such arrangements that are murky, with their size hard to control," he said.

Public-private partnerships, a mechanism to introduce private capital in public service projects to help ease government's financing pressures, will be more widely used and better regulated next year, analysts said.

Fine-tuning tax cuts

Given slowing fiscal revenue growth and growing demand for government spending, experts also called for fine-tuning the tax cut drive to keep the fiscal deficit increase in check.

Beijing has hoped its ambitious plan to convert business taxes to a value-added tax (VAT) will lessen the burden on companies and boost economic growth.

The logic is that the VAT system will encourage investment because it allows businesses to deduct their fixed assets, including properties and factories, against taxable income.

However, an increasing number of firms have complained that their tax payments actually went up after the reform was broadened in May to cover all industries by including the construction, real estate, consumer and financial sectors.

For example, life insurers saw their tax payments surge by 73% year-on-year in May, 52% in June and 53% in July, Zhao Yulong, an official with industry watchdog China Insurance Regulatory Commission, said in early November.

Officials have blamed the increase on a variety of reasons, such as insufficient deductions as taxpayers needed time to adapt to the new system; bad timing for some sectors, such as the financial industry to buy more property; and the closing of loopholes that previously saw some companies not fully paying their business taxes.

Liu Shangxi, head of the Chinese Academy of Fiscal Sciences, which is affiliated with the Ministry of Finance, urged the 17% VAT tax rate — levied mainly on manufacturers — to be lowered to help the industry upgrade.

Xu Shanda, formerly a vice chief of the State Administration of Taxation, argued the corporate contribution for employees' social insurance must be brought down to improve companies' efficiency.

"There are many considerations for lowering the macro tax burdens; the first should be social insurance" contributions, he said.

He said a total of 20 trillion yuan in state-owned equities will be allocated to replenish the country's social insurance system within the next five years. This is expected to finally slash the corporate contribution rate to 20% of employee salaries from the current 40%.

Overcapacity reduction and deleveraging the economy can really be successful only when the social safety net can properly take care of people who were laid off, he added.

Trimming competition-impeding subsidies

Reducing unnecessary government spending is another way to prevent the fiscal deficit from soaring too rapidly.

Government subsidies in fully competitive industries, for example, will disrupt overcapacity reduction in some traditional sectors, create new "zombie companies" and risk leading new industries to build up excess capacity, said Xue Lan, a partner of investment consultancy Trivest Advisors.

"The government's intention (in subsidizing industries) is good, but (the policy's) impact can't be worse," she said.

Liu also said various government subsidies for some companies and industries must be scaled down to "protect fair market competition."

Some said the government could instead subsidize investment in people by compensating vocational education programs and company employee training costs.

Contact Fran Wang (fangwang@caixin.com)

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