China Congress Muddles Through Budget Mess -- Heard on The Street

By Aaron Back 

        China's 2015 budget is out, and it doesn't add up. It will take a great deal of creative accounting at the local-government level to avoid a recession-inducing fiscal squeeze.
        At the start of the annual meeting of the National People's Congress on Thursday, Premier Li Keqiang, as widely expected, lowered Beijing's target for economic growth this year to about 7% from 7.5%. But he left unanswered key questions over one important driver of growth: government spending.
        China is walking to the edge of a fiscal cliff. A new budget law that takes effect this year bans new borrowing by local government financing vehicles, essentially off-balance-sheet platforms that allow provinces and cities to get around official restrictions on debt issuance. These vehicles borrowed around 1.4 trillion yuan ($223 billion) last year to fund infrastructure projects and other local government spending priorities, according to ANZ.
        Cutting off this source of funds would mean an immediate fiscal contraction of around 4.5% of gross domestic product. That would make it nearly impossible to meet even the lowered growth target.
        Mr. Li's speech on Thursday could have explained how China will avoid this hit, but didn't. He said that China's total budget deficit, including both local and central governments, will rise to 2.3% of GDP this year from 2.1% last year, less than the roughly 2.5% of GDP economists expected. The quota for local government bond issuance will rise by 100 billion yuan, to 500 billion yuan. Local governments will also get an allowance to issue an additional 100 billion yuan of debt from supplemental budgets backed by land sales. All this won't be nearly enough to plug a 1.4 trillion yuan shortfall.
        Since the lower growth target was widely expected, it was likely Beijing's tight fiscal stance that sent stock prices lower in Hong Kong and Shanghai on Thursday.
        In theory, new public-private partnerships, which would tap funds from private companies, could plug the financing gap. But this is an entirely new model of project finance in China that will take months or perhaps years to start running at full scale.
        The reality is that there will be still more accounting gymnastics this year to keep spending taps at least partially open. Mr. Li hinted at this, saying China will "ensure continued financing for eligible projects already under construction." He also said local governments will be allowed to issue an appropriate amount of "special-purpose bonds, " without elaborating on what that means.
        While a disastrous fiscal crunch will be avoided, some local-government austerity is inevitable as China weans itself off debt-fueled growth. That means more pain in store for already-suffering sectors such as property developers, construction companies and raw-material producers. The lack of clarity from Beijing on budget policies only adds to uncertainty for investors.
        Beijing seems intent to muddle through the transition to a new budget system. China won't be racing off a cliff, but it still looks stuck in the fiscal mud.
        Write to Aaron Back at aaron.back@wsj.com
        (END) Dow Jones Newswires

        March 05, 2015 03:17 ET (08:17 GMT)

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