Continued fiscal weakness threatens the CCP’s governing capacity; Beijing’s latest economic support policies unlikely to spur sustained recovery

  1   Continued fiscal weakness threatens the CCP’s governing capacity

  Fiscal revenue continues to shrink

Sept. 20
The PRC Ministry of Finance released fiscal revenue data for January to August 2024.

General public budget revenue

• The national general public budget revenue for the January-August period decreased by 2.6 percent year-on-year to 14.8 trillion yuan, with a comparable growth rate of 1 percent.
  • The national tax revenue decreased by 5.3 percent year-on-year to 12.1 trillion yuan, while the non-tax revenue increased by 11.7 percent to reach 2.7 trillion yuan.
  • Revenue generated from key tax items include:
    • Domestic value-added tax revenue decreased by 4.9 percent year-on-year to 4.6 trillion yuan.
    • Domestic consumption tax revenue increased by 4.2 percent year-on-year to 1.1 trillion yuan.
    • Corporate income tax revenue decreased by 5 percent year-on-year to 3.1 trillion yuan.
    • Personal income tax revenue decreased by 5.2 percent year-on-year to 968.5 billion yuan.
    • Stamp duty on securities transactions decreased by 55.5 percent year-on-year to 65.3 billion yuan.

General public budget expenditure

• The national general public budget expenditure for the January-August period increased by 1.5 percent year-on-year to 17.3898 trillion yuan.
  • Debt servicing expenditure increased by 5.6 percent year-on-year to 822.6 billion yuan.

National government fund budget revenue and expenditure

• The national government fund budget revenue for the January-August period decreased by 21.1 percent year-on-year to 2.7 trillion yuan.
  • Revenue from the sale of state-owned land use rights decreased by 25.4 percent year-on-year to 2 trillion yuan.
• The national government fund budget expenditure for the January-August period decreased by 15.8 percent year-on-year to 4.8 trillion yuan.
  • Expenditure related to land-use rights sales decreased by 10.1 percent year-on-year to 2.8 trillion yuan.

  Finance ministry spotlights hidden debt accountability

Sept. 19
The Ministry of Finance issued a report spotlighting eight typical cases of hidden debt accountability issues that were uncovered during the 2023 fiscal oversight campaign.

The cases are:

• The Tianjin Port Free Trade Zone local government in Tianjin added to its hidden debt by directly borrowing 7.397 billion yuan from local state-owned enterprises.
• The Bayuquan District (Liaoning Province) local government added to its hidden debt by borrowing 1.996 billion yuan from local SOEs.
• A publicly funded vocational school in Hunan Province created 450 billion yuan of hidden debt through a “lease-to-build” arrangement.
• The Dongxiang District (Jiangxi Province) local government added to its hidden debt by borrowing 340 million yuan through local SOEs.
• The Meihekou City (Jilin Province) local government added to its hidden debt by borrowing 298 million yuan through public hospitals and other entities.
• The Baotou City (Inner Mongolia) local government borrowed 68 million yuan from a financial leasing company to make repayments on existing hidden debt, but falsely claimed this as debt resolution.
• The Lingao County (Hainan Province) local government required an agent bank to provide funds to pay off a hidden debt of 840 million yuan, which had not been settled for an extended period.
• The Yongning Country (Ningxia Hui Autonomous Region) local government created 320 million yuan in hidden debt through using rural water supply and agricultural irrigation concession rights as collateral for financing.

The Lingao County of Hainan Province is requiring an agent bank to advance funds to cover a new implicit debt of 840 million yuan, which has remained unsettled for a long time.

The report said that the eight cases reveal that some local leading cadres (government and work units) have a “distorted view of political achievements, lack strict discipline, and failed to fully implement the decisions and policies of Party Central and the State Council.” Those cadres also “disregarded orders and prohibitions, and compromised or circumvented policies, which severely impacted efforts to prevent and mitigate hidden debt risks.”

The report also emphasized that the finance ministry would strictly investigate and hold accountable any new hidden debt or false debt resolution efforts. The finance ministry would also ensure that violations are addressed as soon as they are discovered.

  Hunan finance chief murdered

Sept. 19
The CCP authorities announced that Liu Wenjie, the Party secretary and director of the Hunan provincial department of finance, was murdered. The Hunan provincial finance department released an obituary describing Liu, 58, as an “outstanding Party member” and said her death was “a significant loss to Hunan’s financial sector.”

A police report identified Liu as the victim without mentioning her position and named two suspects, a man surnamed Jiang (江某輝) who was a business order in the furniture industry who had accumulated over 12 million yuan in gambling debts in Macau, and another man surnamed Jiang (江某) with no details about his occupation.

The police report said Liu was attacked by the two suspects as she opened the door to leave her apartment on the 13th floor of a building. The two suspects held her at knifepoint and forced her back into the apartment. Liu and the second suspect subsequently fell off the balcony simultaneously, with the balcony showing signs of struggle. The first suspect attempted to escape by tying two curtains together and descending to the 12th floor, but fell to his death during the attempt. The report said that the investigation found no prior connection between Liu and the two suspects before the incident.

The official report and information in official media differed from information circulating on Chinese social media:

• Social media information claimed that the two suspects tied up Liu Wenjie and placed her on the balcony, where she either was pushed off or fell accidentally. Before falling, Liu allegedly made several phone calls in an attempt to raise money, but was unsuccessful.
• The names of the two suspects are allegedly Jiang Yihui (age 31) and Jiang Hui (age 35). Jiang Yihui was a representative of the Pingjiang People’s Congress in Hunan Province and a member of the Chinese People’s Political Consultative Conference. He owned multiple luxury cars and several businesses. Jiang Hui had previously been recognized as one of Yueyang City’s “top 100 outstanding youth.”
• Caixin reported that Jiang Hui and Jiang Yihui had been business partners with a close relationship. Jiang Yihui was known for his charitable activities and was described as honest and good-natured. Many of the two suspects’ friends and local villagers expressed disbelief at his actions, saying, “We don’t believe that they would do what the report claims.”
• Jiang Hui’s wife publicly protested her husband’s innocence online, stating that she had been unable to reach him for days before the incident and she did not believe that he would commit murder.
• Liu Wenjie was reportedly involved in providing guarantees for a real estate company in Hunan’s Changsha City. In October 2020, she allegedly borrowed 60 million yuan with an annual interest payment of 9 million yuan from Jiang Hui and Jiang Yihui. A conflict allegedly arose when the two suspects visited Liu at her home to demand owed interest and principal repayments, resulting in a violent confrontation.
• Liu was reportedly involved in guaranteeing private loans amounting to 240 million to 250 million yuan.

***
The official website of the Hunan provincial department of finance listed Liu Wenjie as responsible for the budget department and the fiscal supervision bureau (audit office), alongside her main positions.

  Our take

1. The official fiscal data for the first eight months of the year bodes ill for the economy. For one, fiscal revenue declined by 2.8 percent from a year ago in August after factoring out the impact of lower taxes and deferrals. However, deferred tax payments for micro and small enterprises were only until May 2023, and the tax reduction policies introduced in mid-2022 should have lowered the base for the second half of the year. That fiscal revenue continued to decline despite those factors suggests that China’s economic decline would be difficult to reverse in the short term.

The growth rate of revenue generated from key tax items in August also hints at recession:

• Domestic value added tax revenue decreased by 1.7 percent year-on-year to 463.3 billion yuan.
• Domestic consumption tax revenue decreased by 4.6 percent year-on-year to 129.8 billion yuan.
• Corporate income tax revenue increased by 20.1 percent year-on-year to 68.3 billion yuan.
• Personal income tax revenue decreased by 2.9 percent year-on-year to 115.6 billion yuan.
• Stamp duty on securities transactions decreased by 59 percent to 11.8 billion yuan.

The sharp increase in corporate income tax is due to the low base caused by tax cuts in 2023. However, the performance of other key tax items reflects declining corporate profits, shrinking consumption, reduced personal income, and sluggish activity in the capital market.

One of the central reasons for China’s fiscal shortfall is the collapse of the real estate bubble. This led to a significant drop in land-related revenues; national land sales revenue fell by more than a quarter during the January-August 2024 period, and related expenditures created an 800 billion yuan deficit.

2. Local governments and officials appear to be resorting to various illegal measures to raise funds to address fiscal shortages and boost their political achievements. Such measures, however, are causing problems and are gradually eroding the CCP’s governance capacity.

i) The PRC finance ministry’s report on eight cases of hidden debt accountability issues in 2023 exposes just the tip of the iceberg of local financial troubles.

Local officials often take on hidden debt to raise funds and secure political achievements to win promotion. Over time, outgoing local officials leave massive debt problems and risks for their successors and the central government. In a July 14 article on China’s hidden debt, The Wall Street Journal noted that economists estimate the size of hidden debt in China to be between $7 trillion and $11 trillion, or twice the size of the central government’s debt. Economists also say that as much as $800 billion of that debt is at a high risk of default.

The Journal added that Beijing could pay for bailouts if financing vehicles cannot meet their obligations, but the move would encourage unsound borrowing and could create a bigger problem. Alternatively, Beijing could allow insolvent funding vehicles to fail, but this would expose Chinese banks to serious losses and potentially trigger a credit crunch that would further weaken economic growth.

ii) The eight cases of hidden debt accountability issues aside, local governments and officials also resort to other measures to increase fiscal revenue and pad their political achievements, including:

• Manipulation of data to inflate fiscal revenue. Mainland media reported in mid-August 2024 that the issue of local governments inflating fiscal revenue is an “old problem.” Mainland media said that audit reports from some provinces and cities revealed that certain local governments had been conducting financial fraud. For instance, three cities and three counties in Guangdong Province inflated their fiscal revenues by 17.101 billion yuan. Professor Shi Zhengwen from China University of Political Science and Law criticized the practice, saying that local governments’ concealment of actual fiscal deficits exacerbates local financial risks and interferes with the central government’s understanding of the actual fiscal situation.
• Undertake various projects despite facing fiscal shortages and delay payments to private enterprises. The central government has frequently brought up this issue but has yet to resolve it. Some local governments have even resorted to “debt criminalization” to avoid repaying creditors.
• Issue government guarantees or credit enhancements to secure funding.
• Use shady financial platforms to fund various projects.
• The death of Hunan provincial financial chief Liu Wenjie could be linked to an illegal government-backed financing method. The information being circulated about the case suggests that Liu could have acted as a guarantor for a real estate company’s loan (due to political and business connections, an exchange of mutual benefits, etc.) as opposed to the explanation that she had gotten into trouble over a personal loan. The private entrepreneurs who issued the loan could have faced pressure over their inability to get repayment and resorted to extreme actions. However, there are many other potential reasons why Liu was murdered that cannot be ruled out.

iii) Some local governments in economically underdeveloped regions have resorted to various means to confiscate the assets of individuals or companies to increase revenue, essentially “robbing” private enterprises and damaging the business environment. This practice, which mainland media refers to as “deep-sea fishing” style law enforcement (遠洋捕撈式辦案), could be one of the reasons why non-tax revenue saw significant growth in recent years.

In an article published on Sept. 3, Zheshang Magazine detailed how Xinhu Group, a well-known enterprise in Zhejiang Province, was targeted for “deep-sea fishing” by the Hubei authorities. Zheshang Magazine noted that the judicial authorities in Hubei’s Huangshi City revisited an incident from 14 years ago involving Xinhu Group’s legal acquisition of a loss-making coal mine in Xinjiang to go after the company. One of the mine’s former shareholders was accused of bribery and Xinhu Group was held responsible. The case meant that the Huangshi State-owned Assets Supervision and Administration Commission could potentially confiscate Xinhu’s mine, which was now worth hundreds of billions of yuan (the mine was a 10 million yuan liability when acquired). As a result, Xinhu Group faced financial strain and defaulted on a 4.6 billion yuan trust product. The incident sparked strong pushback from scholars in Zhejiang’s economic, legal, media, and business circles.

Another “deep-sea fishing” case led to the detention of Xiao Yonghui, the financial director of the Shenzhen-based mobile phone manufacturer Transsion Holdings, by the supervisory commission of Zhen’an District in Liaoning Province. Xiao was only released on Sept. 17. Transsion is the second-largest mobile phone brand globally.

Around mid-September, a notice that was reportedly issued by a grassroots police station in Zhejiang’s Hangzhou City made the rounds online. The notice instructed enterprises, “If non-local police officers enter enterprises to handle cases without the accompaniment of local police, immediately call 110 and take photos as evidence.”

The practice of “deep-sea fishing” is proving to be disruptive. Mainland media and social media note that “deep-sea fishing”-style law enforcement has become widespread and is seriously affecting local business environments and local government fiscal revenues. With the rise of online financial fraud in China, some legitimate businesses saw the freezing of their funds and bank accounts after some fraudulent groups opted to launder money through currency exchanges or the purchase of gold. Some have also raised concerns that certain law enforcement departments may be using entrapment tactics to falsely incriminate businesses, resulting in significant losses for the businesses affected.

“Deep-sea fishing” law enforcement has also fueled a warped sort of local “protectionism.” For instance, some local governments have resorted to preemptively detaining business personnel in their localities to “protect” local businesses from being targeted by police from other jurisdictions and thereby preserve streams of local tax revenue. The rise in local “protectionism” threatens to undermine the central government’s plan to establish a unified national market and worsen the business environment in China.

3. Beijing has yet to find a solution to deflation and other economic problems. This means that China’s fiscal problems and associated issues will likely grow.

If the central government lacks the fiscal capacity to sustain local operations, localism could emerge as administrations in various regions begin to prioritize their own interests potentially in contravention of Beijing’s authority. Should such a trend emerge, it could signal the early stages of regional fragmentation, a deeply troubling development for Party Central and the PRC central government.

  2   Beijing’s latest economic support policies unlikely to spur sustained recovery

  PBoC rolls out rate cuts, other stimulus

Sept. 24
1. The People’s Bank of China announced a series of measures to support the economy.

RRR cut

• The PBoC will cut the reserve requirement ratio by 50 basis points in the near future, freeing up about 1 trillion yuan for new lending. Central bank governor Pan Gongsheng said that the RRR could be further lowered by 0.25 to 0.5 percentage points depending on the market liquidity situation later in 2024.

Rate cut

• The PBoC will cut the seven-day reverse repo rate by 0.2 percentage points to 1.5 percent. Pan Gongsheng said he expects the measure will guide the medium-term lending facility (MLF) rate lower by about 0.3 percentage points, and the loan prime rate (LPR) and deposit rates lower by 0.2 to 0.25 percentage points. Pan expects the impact of the rate cuts on banks’ margins to be neutral, and did not say exactly when the moves would come into effect.

Lower existing mortgage rates

• The PBoC will guide commercial banks to lower the interest rates on existing mortgages by 0.5 percentage points on average. Pan Gongsheng expects the move will benefit around 50 million households, and that they would pay 150 billion yuan less in interest a year.

Lower down payment

• The minimum down payment ratio for second-hand home buyers would be lowered to 15 percent from the current 25 percent.

Re-lending loan facility

• The PBoC will allow commercial banks to use 100 percent (up from the current 60 percent) from a 300 billion yuan re-lending loan facility to finance loans offered to state-owned enterprises to acquire unsold flats for affordable housing. The central bank will also consider allowing policy banks and commercial banks to provide lending for good quality companies to acquire land from developers, as well as provide re-lending loans “when necessary.”

Capital market

• The PBoC will set up a 500 billion yuan swap facility allowing securities firms, funds, and insurance companies to tap liquidity from the central bank to purchase equities. Pan said that the authorities are open to adding 500 billion yuan followed by another 500 billion yuan in phases.
• The central bank will set up a specialized re-lending facility to provide 300 billion yuan to commercial banks to finance listed companies’ and major shareholders holders in making share purchases and buybacks.

Stock market

• The China Securities Regulatory Commission will issue guidance for medium and long-term funds to enter the market, as well as measures to promote mergers, acquisitions, and reorganizations.
• The CSRC will further support the state fund Central Huijin Investment in stock purchases and expanding investment scope.
• The CSRC will optimize the registration of equity-focused fund products and promote the innovation of broad-based exchange-traded funds and other index products.

Stabilization fund

• Pan Gongsheng said that the PBoC is studying the establishment of a stabilization fund for the stock market, but did not elaborate on the size of the fund or the timetable for its establishment.

2. Bloomberg News reported that Pan Gongsheng’s press conference was “hastily arranged only 48 hours earlier” after weeks of “growing anxiety among top leaders in Xi’s government,” citing people familiar with the matter. The people said senior policy makers held several unscheduled closed-door meetings to discuss the economy as it became clearer that Beijing’s growth target for 2024 was moving out of reach. The people said that officials in at least one major coastal province that is an important growth contributor warned that it would struggle to hit its GDP target.

Bloomberg said officials suddenly received requests last week for more information on economic revival policy proposals after waiting months for feedback, forcing some to pull all-nighters before Pan’s briefing.

Sept. 25
The PBoC cut the MLF rate to 2 percent from 2.3 percent, the biggest reduction since the central bank began using the monetary tool to guide market interest rates in 2016.

  Shares price rise

The PBoC’s measures led to a surge in shares:

• Sept. 24: U.S.-listed shares of Chinese firms like Alibaba, PDD Holdings, and Li Auto rose by 7.9 percent, 11.8 percent, and 11.4 percent respectively.
• Sept 24: MSCI gauge of stocks across the globe grew by 0.54 percent to 844.56, a record high. The iShares MSCI China ETF climbed 6.4 percent.
• Sept. 24: The Dow Jones Industrial Average rose 0.2 percent to 42,208.22, the S&P 500 rose 0.25 percent to 5,732.93, and the Nasdaq Composite rose 0.56 percent to 18,074.52.
• Sept. 24: The Shanghai Composite Index rose 4.15 percent to 2,863.13 points. The total trading volume of the Shanghai and Shenzhen indexes reached 970 billion yuan. Previously, the Shanghai index had closed below 2,800 points for 12 consecutive trading days and the total trading volume of the two indexes fell below 500 billion yuan on two of those 12 trading days.
• Sept. 25: The Shanghai index climbed above 2,900 points during intra-day trading before closing up 1.16 percent at 2,896.31 points. The total trading volume of the Shanghai and Shenzhen indexes reached 1.16 trillion yuan.

Previously, the Shanghai Composite Index had closed below 2800 points for 12 consecutive trading days, with the total trading volume of the Shanghai and Shenzhen markets falling below 500 billion yuan on two of those days.

  Backdrop

On Sept. 18, the U.S. Federal Reserve cut its benchmark overnight borrowing rate by 50 basis points to a targeted rate of 4.75 percent to 5.00 percent.

  Our take

1. We see several possible reasons why the PBoC has announced a raft of policy measures to support the economy at this time:

• The policy measures are an indirect acknowledgment by Beijing that the economic situation in China is particularly bleak. This is underscored by Bloomberg’s information that Pan Gongsheng’s press conference and the raft of measures were seemingly arranged at the last minute. The CCP authorities are being forced to take actions of some sort, even those that are more performative than substantive, to answer calls for it to do something to reverse China’s economic malaise.
• The CCP authorities could be looking to take advantage of the Fed’s recent rate cut and likely further rate reductions before the end of the year to carry out monetary easing, thereby preventing a widening of the yield spread between the U.S. and China 10-year government bonds.
• Beijing could be looking to address the issue of low liquidity in the A-shares market and trading volumes repeatedly hitting new lows. Stock market woes are affecting the “national team,” which is likely struggling to prop up the market and is trapped in losing positions.
• Beijing needs a way to deal with rising financial system risks. Notably, the net interest margins of banks have been shrinking, leading to the consolidation or closure of several small and medium-sized banks.
• Beijing needs to reverse steadily declining government bond yields. On Sept. 23, the 10-year government bond yield hit a new low of 2.0381 percent.
• Finally, the CCP authorities need to generate some “positive news” and results ahead of the 75th anniversary of the founding of the PRC on Oct. 1.

2. The PBoC’s latest round of monetary easing, the magnitude of which exceeded expectations, appeared to lift sentiments and boost capital markets, at least in the short term. The raising of stock prices would come as a reprieve to the “national team” (the ad-hoc task force of large state-affiliated institutions that intervene to prop up the stock market), which has been propping up the A-shares market for nearly a year, while slightly easing banking sector risks.

The gains in the mainland and Hong Kong stock markets appear to be largely attributable to the favorable reaction to three of the recent central bank measures, namely, the swap facility, the specialized re-lending facility, and the proposed stabilization fund. The swap facility allows securities firms, funds, and insurance companies to use their bonds, exchange-traded funds, and CSI 300 index constituents as collateral to access central bank liquidity to purchase equities. Meanwhile, the specialized re-lending facility further enables non-financial institutions to engage in arbitrage opportunities.

The “national team” is expected to benefit the “national team,” SOE stocks, and financial stocks. Previously, the “national team” purchased large amounts of CSI 300 ETFs during market stabilization efforts, which primarily comprised SOE and banking stocks. By pledging these ETFs to the central bank in exchange for government bonds and subsequently selling the bonds at current high prices, the “national team” can bring the currently low bond yields back to a reasonable level and reduce the interest rate spread between China and the United States. The “national team” can also use proceeds from bond sales to repurchase CSI 300 ETFs, further lifting SOE and banking stocks.

The “national team” can repeat the arbitrage strategy in a rising market and help to mitigate the financial risks of banks facing declining profits. The semi-annual financial reports of 42 listed banks show net profit growth of just 0.37 percent from a year ago. Of the six major state-owned banks, only the Agricultural Bank of China posted marginal growth (0.29 percent) while the rest saw declines. Additionally, the average net interest margin of the 42 banks stood at 1.64 percent, with large commercial banks (1.46 percent) and city commercial banks (1.45 percent) showing margins below the non-performing loan ratio of 1.56 percent in the second quarter of 2024.

However, non-financial institutions could increase their leverage and financial risks if they repeatedly abuse the swap facility and the specialized re-lending facility to engage in arbitrage. Even greater financial risks could potentially be triggered should the current upward market trend fail to sustain (likely given the general lack of confidence in China’s A-shares market and economic prospects) and sharp declines follow.

3. The PBoC’s recent rate cuts, RRR reductions, and lowering of mortgage rates are likely to provide short-term support to the real estate market and spur consumption to a degree. However, we believe that these measures are unlikely to halt the ongoing trends of early mortgage repayments and weak consumption.

The lower of interest rates on existing mortgages by 0.5 percentage points on average could partly alleviate the problem of early repayments and credit shrinking in China. But early repayment will likely remain the most attractive financial option for households as banks lower deposit rates. Several small and mid-sized banks recently announced deposit rate cuts, with some reductions reaching up to 40 basis points, according to mainland media reports. We believe that these cuts could be a precursor to similar moves by major state-owned banks.

While the lowering of existing mortgage rates could help 50 million households save an estimated 150 billion yuan annually in interest payments, the measure’s impact on boosting consumption is still limited. The 150 billion yuan in interest payment savings averages to just 3,000 yuan per household. And even if consumers were to spend all the savings they made on interest payments, it would account for just 0.32 percent of the 2023 retail sales of consumer goods (47.1 trillion yuan).

Finally, banks still face a challenge in finding qualified borrowers even with the central bank’s rate cuts and RRR reductions given the current environment of declining asset prices, falling property values, and reduced household incomes.

5. We believe that the PBoC’s latest policy measures are akin to applying a bandage without addressing the underlying issues plaguing the Chinese economy. The policies could also worsen existing problems further down the road as financial institutions take on more leverage.

The main problems facing China’s economy today are weak consumption and deflation, not a lack of liquidity in the financial system. Those problems in turn are caused by households and businesses lacking confidence in the future and becoming unwilling to spend and invest. The spending and investment hesitancy is likely to worsen as local governments facing fiscal shortages increasingly turn to fines and penalties to increase non-tax revenue, raise fees for public services and transportation, as well as conduct 30-year retroactive tax investigations. On top of that, the central government’s reform of the healthcare system and delaying of the retirement age, which are aimed at reducing expenditures, would further squeeze household spending capacity and exacerbate deflation.

The current round of monetary easing is also unlikely to bring tangible benefits to the general public. If anything, the policy measures are likely to widen the rich-poor gap and worsen social inequality. Monetary easing could also potentially drive up the prices of essential goods in the future, further eroding consumer’s purchasing power.

To stimulate consumer spending, the CCP authorities should be looking to increase fiscal spending on social security for residents. Such a move would give households greater peace of mind to spend instead of worrying about saving for rainy days. However, the systemic deficiencies of the CCP authoritarian system (widespread corruption, degradation of social ethics and morals, etc.) would likely diminish the effect of the aforementioned policy as local governments and corrupt officials are bound to siphon off a portion of the allocated funds. Unless the leadership is willing to consider doing away with the current political system and truly liberalizing China, the CCP authorities will find it exceedingly difficult, if not impossible, to resolve the fundamental issues troubling the Chinese economy.