Chinese Finance: The leverage ratio of the central government in our country is low and there is still room for the central government fiscal deficit to expand in the coming years.

On March 3rd, an article titled "Basic Understanding of the Current Fiscal Deficit Issue in China" was published in the central financial media "China Finance" supervised by the Ministry of Finance. It stated that from a structural standpoint, the leverage ratio of China's central government is relatively low (less than 30%), and there is still room for the central fiscal deficit in the coming years. However, from a long-term perspective, pursuing fiscal cyclical balance remains our goal. Otherwise, the continuous accumulation of fiscal deficits will bring about a series of problems: on the one hand, the increase in debt interest payments will increase the financial burden, leading to rigid expenditure structures, which is not conducive to the health and sustainable development of the fiscal system. On the other hand, the continuous increase in demand for government bonds will continuously drive up interest rates, prompting commercial banks to continuously purchase government bonds, thereby leading to an increase in the central bank's money supply, exacerbating the risk of inflation.Funds can be raised through borrowing domestic and foreign debts, but borrowing should be of a reasonable scale and structure. Budgets at all levels of local governments are prepared on the principle of balancing revenues and expenditures, without running deficits. The revised "Budget Law of the People's Republic of China" in 2014 explicitly states that the general public budget of the central government may run deficits if necessary for macroeconomic policy adjustments, and borrowing debts should be kept at an appropriate scale with a reasonable structure. Local general public budgets must still not run deficits, and for necessary construction investment funds in budgets of provinces, autonomous regions, and municipalities directly under the central government approved by the State Council, funds may be raised by issuing local government bonds within the limits set by the State Council. Borrowed debts must have a repayment plan and stable sources of repayment funds, and can only be used for public welfare capital expenditures, not for routine expenditures. Local governments and their departments are not allowed to borrow or provide guarantees in violation of regulations. Overall, the new budget law provides more objective and standardized management of budget deficits, in line with the needs of China's economic and social development and modern financial management.Since 1979, the deficit in our country has mainly been the central government fiscal deficit, with local surpluses able to offset the central government fiscal deficit. As shown in Table 1, since 2010, local fiscal deficits have become the norm, which is also the main reason for the accumulation and expansion of local government debt. The size and ratio of local fiscal deficits reflect the balance of local general public budgets, which is currently overall manageable. However, it is important to note that with the recent softening of the real estate market in China and the decrease in income from state-owned land transfer fees, the revenue and expenditure gap in local government special funds budgets may evolve into potential or implicit deficits. Table 1 Central and local fiscal deficits from 2010 to 2024 Deficits and Government Bonds From the standpoint of fairness in intergenerational burden-sharing of public investment project costs and improving the efficiency of public capital formation, government debt is an indispensable part of fiscal operations. China is a developing country, and as economic system reforms deepen, reform comes with costs, often manifested as reduced revenue and increased spending. National finances not only have to meet the needs of many people for social security, education, and other basic services but also have to undertake responsibilities for macroeconomic regulation and economic development. The issue of fiscal imbalance has always been a prominent contradiction in the process of reform and development. Issuing government bonds (including central government debt and local government debt) is a common practice worldwide to offset deficits and is considered the most reliable approach for addressing deficits. In recent years, with the increasing annual fiscal deficits, the scale of government debt in China has been accumulating every year, making it crucial to guard against fiscal risks. A deficit is a flow, while government bonds are a stock. The risk of fiscal deficits can be reflected through the debt ratio. The debt ratio is the ratio of government debt to annual GDP, where the government debt balance is the total accumulation of all past deficits (with fiscal surplus as negative). The deficit ratio is positively correlated with the debt ratio, and it is used to assess the long-term debt repayment capacity. In addition, the interest rate on government bonds is also crucial; a high interest rate will increase the cost of issuing government bonds, expanding the size of fiscal deficits, while a low interest rate or negative interest rate can make it more difficult to issue government bonds. Monetizing deficits has always been a focus of attention. The "Law of the People's Republic of China on the People's Bank of China" adopted in 1995 stipulates that the central bank may not lend to or overdraft the government's funds, nor can it directly purchase government bonds. However, the central bank can indirectly finance fiscal deficits by purchasing government bonds through open market operations. For nearly 30 years, the Ministry of Finance has strictly adhered to the principle of not borrowing directly from the central bank or overdrafting, and Chinese government bonds have always been favored by various commercial banks and financial institutions, making it unnecessary to overdraft. Comparison of deficit levels in major world economies Looking at the development history of modern national finances, fiscal deficits are a global economic phenomenon, and there is no specific rule for the level of deficit rates. The Stability and Growth Pact (SGP) of the European Union (EU) in 1997 stipulates that member states' fiscal deficits cannot exceed 3% and debt ratios cannot exceed 60%. To adapt to the changing economic situation and policy needs, the above provisions have undergone some modifications and adjustments in the past 30 years. For example, in 2005, to strengthen EU fiscal discipline and coordination, the concept of "medium-term budgetary targets" was introduced, requiring EU member states to not only focus on the annual deficit rate but also establish and adhere to medium-term sustainability goals. After the European debt crisis in 2012, member states were allowed to moderately adjust the deficit rate ceiling under specific conditions and increased attention to economic growth, employment, and social inclusion. Overall, the treaty's constraints are not very strong, and the fiscal discipline of EU countries has become more relaxed. Since the beginning of this century, major economies around the world have experienced significant fluctuations in deficits due to the global financial crisis and the pandemic. As shown in Figure 2, the deficit rate in the UK sharply rose from 2.8% in 2007 to a peak of 11.4% in 2009, gradually declining with economic recovery and implementation of fiscal austerity policies to 1.5% in 2019. In 2020, due to the impact of the COVID-19 pandemic, the deficit rate surged to 15.5%, and in 2023, energy subsidies pushed up spending, resulting in a deficit rate of 4.4% and a government debt ratio exceeding 100%. France's deficit rate reached 7.5% in 2009, decreased to 2.9% in 2019, and then surged to 12.7% in 2020 due to the pandemic. Germany has performed well in terms of fiscal discipline, with a deficit rate of 3.3% in 2010 and a rise to 3.7% in 2020 due to the pandemic, but mainly remaining at low levels in other periods, achieving fiscal surpluses between 2014 and 2019. Due to the financial crisis, the United States' federal deficit rate reached 9.8% in 2009, steadily declining in subsequent years, rising to 14.7% in 2020 due to the pandemic, and falling to 11.8% in 2021 and projected to be 5.8% in 2023 (according to the CBO), relying on the hegemony of the US dollar to maintain financing ability, with federal debt reaching 122% of GDP in 2023. Japan divides government debt into construction bonds and deficit bonds, only using income from deficit bonds to offset deficits, maintaining a long-term deficit rate exceeding 4% and a debt balance/GDP ratio exceeding 260%, with the Bank of Japan purchasing debt to lower interest rates but facing increased fiscal pressure due to aging population. Figure 2 Fiscal deficit rates in major world economies since 2000 Future deficit space and applications in China The deficit space depends on future economic growth expectations, as well as the current economic cycle and the efficiency of deficit utilization. For China's fiscal deficit policy, it is important to hold an objective and scientific attitude, follow economic laws, plan the size and structure of the deficit rationally, focus on improving the efficiency and effectiveness of fund utilization, aim for periodic fiscal balance, ensure the healthy and sustainable development of public finances, and provide strong guarantees for the comprehensive construction of a socialist modernized country by 2050. (1) Future deficit space. Structurally, China's central government debt ratio is relatively low (less than 30%), so there is still room for the central government's fiscal deficit in the next few years. However, in the long run, pursuing periodic fiscal balance remains our goal. Otherwise, the continued accumulation of fiscal deficits will bring about a series of issues: on one hand, the increase in debt interest expenses will increase the fiscal burden, leading to a rigid expenditure structure that is not conducive to fiscal health and flexibility.Sustainable development; On the other hand, the continuous increase in demand for government bonds will continue to push up interest rates, prompting commercial banks to continuously purchase government bonds, thereby leading to an increase in the central bank's money supply, exacerbating the risk of inflation.(2) Preventing local government debt risks. Considering the existence of implicit and contingent debts, some local governments may face the dilemma of implicit deficit finances, which should be highly concerned. A comprehensive and systematic analysis is needed for the financial situation of local governments, and risk prevention and control measures should be strengthened based on their financial sustainability. For cities and counties with good financial conditions, the limit on fiscal deficits can be moderately relaxed, but achieving fiscal balance in the medium term is required. For cities and counties with financial problems, strict control of contingent deficits and new implicit debts is necessary. (3) Efficient use of fiscal deficits. Deficits essentially involve prepayment of future tax revenues. With the increasing dependence of fiscal deficits, it means that the cost of fiscal funds is higher, so more attention should be paid to the direction and purpose of deficit utilization. These funds should not only meet the public service needs of the present generation, but also lay the foundation for future economic and social development, achieving cross-cycle adjustment and intergenerational equity. Firstly, it is necessary to further optimize expenditure structure, fill the gaps in infrastructure and areas of people's livelihood, increase fiscal support for elderly care facilities and childbirth encouragement, focus on basic scientific research and talent cultivation. Secondly, emphasis should be placed on improving the performance of fund utilization, implementing comprehensive budget performance management, emphasizing the comparison of costs and benefits, reducing administrative costs, eliminating loss and waste, ensuring that every penny has the desired effect. Finally, precaution should be taken against crowding out effects on private investment and market activities, strictly adhere to the boundaries of the market and government, adhere to market priority and efficiency priority, fiscal funds should have actions and restraints, avoid disturbing the normal operation of market rules. This article is excerpted from the WeChat public account "Chinese Finance"; edited by GMTEight: Xu Wenqiang.