Keynesian spending statistics don't reveal China's fiscal pain

Conventional wisdom has it that China is insulated from Asia's economic crisis because it can continue - if it wishes - with a Keynesian infrastructure spending package for several years to come.

Widely accepted statistics are used to confirm this view. The budget deficit this year will amount to just 1.8 per cent of gross domestic product, a level that would qualify the country for entry into the European Monetary Union. Total domestic debt is less than 10 per cent of gross domestic product - another eminently respectable ratio.

But employing such statistics to measure China's fiscal health is akin to "climbing a tree to catch fish".

Yardsticks that Beijing does its best to play down show a country in acute fiscal pain. The main problem is that central government revenues last year accounted for just 12 per cent of GDP - well below the developing country average of around 32 per cent and reminiscent of the picture in Russia. This has meant that China's ability to service its domestic and foreign debts is compromised.

For example, 60 per cent of RMB548.3 billion (#61 billion) in total central government revenues last year came not from tax collection but from the issuance of debt. Of the debt raised, 70.9 per cent went on servicing and financing redemptions of other debts.

"The fiscal situation is at the core of our worries," said one analyst at a foreign multinational organisation in Beijing.

Weak central government finances have impinged on Beijing's power to conduct macro-economic policy.

China's ability to pursue its fiscally-driven infrastructure package, which officials claim is the main engine of economic growth, is limited.

Officials, who declined to be identified, said the finance ministry was reluctant to authorise this year another special bond issue to match the RMB100 billion in infrastructure bonds launched last August. But, they added, the ministry was resigned to doing so if the wider economy begins to show marked signs of a slowdown.

The sense of reluctance to launch another Keynesian package coincides with mounting criticism in the official media over how the infrastructure money is being wasted. If the experience in Beijing is any guide, much of the funds are being funnelled into projects with little prospect of a return.

Workers from the countryside are now a common sight in China's capital, digging up paving stones only to lay others in their place and uprooting trees merely to replant them nearby. "It really looks like the `New Deal'," said one foreign diplomat, referring to President Franklin Roosevelt's famous pump priming spree in the US in the 1930s.

But even as money is spent trying to reverse an economic slowdown through pump priming, strains on government finances are growing from other sources.

The swelling ranks of workers laid off from state enterprises, which employ around 60 per cent of the urban workforce, is a mounting burden for a state which has promised to guarantee a basic wage.

Officials said that even the government's forecast of a RMB150 billion budget deficit this year, an increase of 56 per cent on last year and the largest shortfall in two decades of reform, may prove too conservative.

From a different perspective, the fiscal shortage is limiting the government's freedom to regulate the pace of state-owned enterprise reform because it simply cannot afford to waste money keeping inefficient industries afloat, Mr Liu said.

Such is the passive force driving much of China's state-owned enterprise reform.

With this backdrop, it is not surprising the finance ministry has made it a top priority to raise revenues as a percentage of GDP.

Xiang Huaicheng, finance minister, is believed to have made a private target of raising central finances to 20 per cent of GDP by the time his five-year term is up in 2003.

But, paradoxically, an overriding priority this year to maintain social stability and stimulate the economy has forced the government to tailor a relatively slack tax regime. Total tax receipts by central and local governments are expected to grow by just 4.8 per cent to RMB953.3 billion, compared with a 10 per cent climb last year and a gross domestic product growth forecast this year of 7 per cent.