Escalation of the US-China trade war could shave 0.7 to 0.8 percentage points off China’s GDP growth in 2019 when Beijing’s de-leveraging measures have already reduced credit growth to a record low. But Beijing can counter these headwinds.
After several rounds of monetary easing, expansionary fiscal policy holds the key to supporting China’s economy in 2019. We see policy shifting to tax cuts besides easier credit for private firms and a rebound in infrastructure spending, combined with reforms of state-owned enterprises.
Tax on Chinese companies’ profits equals 67 per cent. Reforms in 2018 included lowering firms’ social-security costs, increasing tax-free income thresholds and allowing additional deductions. Some Value Added Tax rates were reduced marginally, but although VAT raises a third of government revenues, the state finances are strong enough to cut further.
Halving VAT on agriculture and services to 5 per cent and cutting the manufacturing rate from 16 per cent to 15 per cent would cost the equivalent of 0.9 per cent of GDP.
However, as manufacturing accounts for two-thirds of VAT payments, cutting that sector’s rate to 13 per cent would be equivalent to 1.4 per cent of GDP with more evenly distributed benefits. Slashing the rate to 10 per cent and lowering the service-sector rate could produce a 1.6 per cent GDP effect, further redistributing resources from government to the private sector.
Beijing’s budget-deficit target of 3 per cent of GDP could be maintained by drawing fiscal deposits or cutting spending. But lower VAT should boost both consumption and corporate investment, with firms investing in technologies that help them stay competitive.
China’s economy is now 78 per cent driven by domestic factors, compared with 45 per cent in 2007. That lifts the multiplier effect because there are fewer leakages.
Although Beijing’s de-leveraging policy is not aimed at the private companies – which account for just 30 per cent of corporate debt but 86 per cent of employment and 70 per cent investment – they are nevertheless impacted as banks shrink their balance sheets. With lenders preferring state enterprises – still seen as safer – private companies turn to costlier venture-capital financing.
To mitigate this, the central bank has eased monetary policies and provided some funds for the private sector. There have also been proposals for lenders to allocate quotas for business.
Infrastructure investment growth slowed from 17 per cent to just 3 per cent in 2018 following tougher regulations on public-private partnerships and shadow-banking. However, relaxing the policy has seen a sharp rebound.
Housing policies are likely to change in 2019 too. Monetisation of the central-bank loans financing shanty-town renovation projects accounted for 15 per cent of national housing sales in 2017, mostly in China’s third- and fourth-tier cities. Ending the programme should slow price rises, stabilising the market.
Meanwhile Beijing is promoting a new concept of ‘competitive neutrality’ that levels the playing field between state-owned and private businesses. This means reforming corporate governance to separate government from the enterprise, making subsidies transparent, and demanding equal returns from the two sectors while imposing similar tax, supervision and procurement treatment.
Reducing the scope for accusations of unfair state support may itself ease trade tensions. But turning competitive neutrality into legally-binding guidance will be challenging: China’s state sector is USD27.2 trillion.
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