Dec 21, 2020 06:57 PM

Year in Review: China’s Careful Exit From Pandemic’s Fiscal and Monetary Policy

China has implemented substantial fiscal and monetary stimulus this year to achieve a post-pandemic economic recovery. But it’s now time to consider withdrawing monetary stimulus and fine-tuning fiscal policies as the recovery quickens.

The consensus of global policymakers is that the exit should be done sooner rather than later. But for China, the picture is particularly complicated. Its current challenge is to carefully manage the pace of the exit given the economy’s high debt levels, as an excessively rapid withdrawal of liquidity could trigger debt crises.

Fiscal policy

Instead of repeating its old playbook of relying mainly on credit expansion, China chose to use fiscal policy to revive the economy this time round. Discretionary fiscal measures amounting to around 4.5% of GDP were announced during this year’s Government Work Report.

Specifically, China has ended a longstanding practice of placing a ceiling of 3% on budget deficits-to-GDP ratio and set a 2020 budget deficit of more than 3.6% of GDP, which means about 1 trillion yuan ($153 billion) will be added to the government deficit. Besides, the central government has also finished issuing 1 trillion yuan in antivirus special government bonds and a total of 3.75 trillion yuan of special local government bonds.

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The government also stabilized employment and economic growth by expanding unemployment insurance, investment and tax relief. In particular, small and medium-sized enterprises have received substantial additional government support, and these stimulus measures appeared to have worked well.

As China’s recovery strengthens, many analysts expect that the government will keep an eye on containing the macro leverage ratio and controlling financial risks. In this regard, fiscal policy will gradually get back to normal. The fiscal deficit is expected to return to around 3% of GDP since China will not introduce new large-scale policies to reduce tax burdens and fees next year.

Monetary policy

Taking lessons from 4 trillion yuan stimulus package after the 2008 financial crisis which created asset bubbles and high macro leverage ratios over the past 10 years, China’s easing monetary policies this time have been much more prudent and restrained. Most of the stimulus measures were introduced in the first four months, including three reserve requirement ratio cuts, interest rate cuts and large-scale open market operations.

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Meanwhile, instead of broad-based easing, the uneven recovery resulted in a targeted easing approach from the People’s Bank of China (PBOC), with more support going to smaller firms and rural sectors, and preventing money from going to the real estate sector and financial markets.

Since early May, the PBOC has slowed down the pace of monetary easing and tolerated a steady increase in money market rates and the 10-year treasury bond yield. In June, PBOC Governor Yi Gang pledged to keep liquidity ample, but he has also said China would need to consider withdrawing policy support at some point.

Managing the pace of the exit will be a big challenge for the PBOC, as it faces a double dilemma between stabilizing growth and preventing risks, and between normalizing monetary policy and the rapid appreciation of the yuan.

On the one hand, regulators do not want to over-use debt to support the economy, as rising indebtedness will push China’s financial system into the abyss of systemic financial risk; on the other hand, given the Fed’s zero interest rate and quantitative easing policies, the PBOC’s normalization of monetary policy will led to a widening gap between China and U.S.’s interest rate differentials, which will result in a quick appreciation of the yuan against the U.S. dollar.

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China may have already made its choice. There are signs that the government will reapply its deleveraging process, as the economy stabilizes. Some analysts believe the country’s problem does not lie in a high macro leverage level, but more in the need for structural optimization.

However, the central government is clearly worried about its increasing macro leverage ratio. After years of deleveraging and cleaning up the shadow banking system, China’s debt-to-GDP ratio experienced a decline in 2018 and a mild increase in 2019. But the ratio rose by 27.4% to 272.8% in the first three quarters of this year from 245.4% at last year’s end, as the country stepped up credit support to mitigate the impact of the pandemic.

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Yi Gang told the Financial Street Forum 2020 that he expects China’s macro leverage ratio to stabilize further next year as the economy expands, after the debt gauge raised in 2020. He also reiterated that monetary policy must strike a balance between stabilizing growth and preventing risks, smoothing out fluctuations in the macro leverage ratio, and staying on a reasonable track in the long run.

We believe that a prudent monetary policy stance and financial regulations will better serve China’s economy. In this regard, a combination of a gradual slowing of the credit expansion and a stable interest rate is anticipated in 2021.

Li Huizi is an analyst of Caixin Global Intelligence, the research arm of Caixin Global (

Contact editor Joshua Dummer (

This article is part of a 10-part series. You can find links to the others below.

Year in Review: China’s Economy Gets Back on Track, but Faces Long Road Ahead

Year in Review: Finance in China in a Word — Deleveraging

Year in Review: China’s Financial Market in 2020 — More Opening, More Regulation

Year in Review: China’s Diplomacy in 2020 ― ‘Wolf Warriors’ in Action

Year in Review: 2020 Exposes Gray Rhino Risks in China’s Financial Sector

Year in Review: Once Darlings, China Tech Giants Face Growing Scrutiny at Home and Abroad

Year in Review: The Year Covid-19 Changed Everything

Year in Review: Drive to Overturn Wrongful Convictions Gains Momentum

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