China moves to refinance local government debt and free resources for growth before Trump unleashes trade war 2.0
As signal-boosting gestures go, the US$1.4 trillion debt swap package China announced today (November 8) could be more pivotal for Xi Jinping’s economy than meets the eye.
The move to refinance local government debt, approved by the Standing Committee of the National People’s Congress, marks the first such undertaking since 2015 to raise the debt ceiling for municipalities.
It comes amid underwhelming economic growth, deflationary pressures, high youth unemployment and fears of another Donald Trump presidency that makes trade wars great again.
Finance Minister Lan Fo’an said the swap arrangement is “a major policy decision taking into consideration international and domestic development environments, the need to ensure the stable economic and fiscal operation, and the actual development situation of local governments.”
Lan reckons the swap might save roughly 600 billion yuan (US$84 billion) in interest payments over five years, freeing additional resources to boost investment and consumption. As of the end of 2023, Lan estimates, China’s outstanding hidden debt was 14.3 trillion yuan.
Few economists think Friday’s step is enough to revive confidence, as evidenced by a drop in stocks and the yuan. Nor do most think it will be the last effort to change the narrative.
As Carlos Casanova, economist at Union Bancaire Privée, sees it, “the local government debt swap program remains insufficient, but additional measures could encourage a recovery in private investment and a broadening of domestic consumption.”
Many economists think a more direct effort to boost household demand might still be needed. What the swap program might do, though, is buy Xi’s Communist Party some time to implement vitally needed reforms.
Everyone knows Team Xi needs to get busy repairing the property sector and strengthening capital markets. It’s also well-known that Beijing must act faster to reduce the dominance of state-owned enterprises and make more space for startups to disrupt the economy. And officials must build more robust social safety nets to encourage households to spend more and save less.
Yet much as global investors crave these upgrades, they don’t often afford Beijing the patience needed to execute them. And efforts to repair, change or tweak China’s economic engines are sure to depress growth somewhat. Markets, though, won’t hear of it.
Any hint mainland growth might disappoint prompts global funds to sell down Chinese stocks. It prods economists everywhere to assess the falloff for global growth, trade flows and commodity prices in often dire, market-deflating terms.
It makes Xi the economic equivalent of a CEO struggling to make a company’s numbers each quarter. This cycle breeds short-termism — and it helps explain why Beijing has been so slow to revamp China Inc.
Granted, Xi’s party does itself no favors by continuing to announce annual growth targets. Setting an arbitrary GDP goal year after year warps incentives and leads policymakers to prioritize stimulus over supply-side retooling.
With this latest stimulus blast, Xi’s reform team might earn some patience from world markets. It’s ambitious enough to reassure skeptics that China is serious about ending deflation once and for all.
Restoring confidence “relies on fiscal and monetary policy support lifting nominal demand,” says Alex Muscatelli, analyst at Fitch Ratings. “If current trends in the domestic economy are exacerbated, price falls could become entrenched.”
Muscatelli adds that the “potential exacerbation of current supply and demand trends coupled with demographic and debt overhang challenges, poses a risk of sustained price falls.”
Avoiding that “exacerbation” means pairing monetary and fiscal stimulus with bold retooling moves to raise China’s competitive game.
Beijing has “ample space for fiscal policy and monetary policy,” Premier Li Qiang said in a speech at the China International Import Expo in Shanghai, adding that China will hit this year’s 5% target. “The Chinese government has the ability to drive sustained economic improvement,” Li said.
Yet Trump’s re-election ups the ante on Beijing. Come January 2025, when he’s sworn in, Trump will be on the clock to slap 60% levies on Asia’s biggest economy, as he vowed he would on the campaign trail.
“To mitigate rising US tariffs on the economy, we believe Beijing would likely scale up fiscal stimulus,” says Robin Xing, a strategist at Morgan Stanley. The more Trump ratchets up trade tensions, Xing says, the more Xi might feel compelled to do to offset them.
Lynn Song, chief China economist at ING Bank, adds that “the odds for a larger policy support package will rise somewhat with a Trump victory.”
Though China is more prepared for a Trumpian assault on world trade, Rick Waters, managing director of Eurasia Group’s China practice, says Beijing might struggle to limit the collateral damage.
“I think the challenge here is that China is still at a structural disadvantage in a trade war because they lack the symmetrical space,” Waters says. “They lack the ability to put tariffs on the US when the US does that to them.”
Song counters that “the first trade war was a game changer; many companies were caught off guard, and investors were left scrambling. This time around, Trump’s proposed tariffs have been in consideration for some time and should come as no major surprise.”
Yet the magnitude of the trade tariffs to come could be unprecedented. Take the 100% tariffs Trump has threatened on Mexican-made cars. How long do CEOs at Toyota and Hyundai think it will be before Trump extends them to Japan and South Korea?
Ian Bremmer, president of the Eurasia Group, says, “the world’s second-largest economy is already underperforming, and Beijing is feeling increasingly defensive about the tariff threats coming from hawks like former Trump trade czar Robert Lighthizer.”
The Chinese, Bremmer adds, “are going to be frantically trying to establish back channels to China-friendly Trump allies like Elon Musk, hoping they can facilitate a less confrontational relationship. Will Trump support that, or will his hawks get the upper hand and push for an even more confrontational approach? Beijing will move cautiously and slowly in this environment.”
Alicia García-Herrero, chief Asia-Pacific economist at Natixis, notes that an “insufficient stimulus package, coming on the heels of Trump’s re-election” would backfire, meaning China “needs to find other sources of growth because trade will not make it.”
Another question is how these and other Trump levies might collide with the US Federal Reserve’s effort to cut interest rates, notes Brendan McKenna, a strategist at Wells Fargo & Co.
More tariffs could fan inflation, he says, adding that the Fed easing “less aggressively” than currently forecast could “act as a tailwind for the dollar.”
China is hardly recession-bound. Data on exports in October, for example, signaled a healthy acceleration — the biggest upshift in activity since mid-2022. Yet some analysts wonder if Beijing might devalue the yuan in retaliation for Trump’s tariffs should Chinese growth suffer significantly.
“Beijing might look to devalue the yuan as they did in 2018-2019 to counter tariff effects and boost export competitiveness,” says Dilin Wu, a research strategist at brokerage Pepperstone.
It’s a difficult balancing act. China, after all, is facing multiple challenges from several angles. And the biggest of all could get worse if the yuan falls. Defaults among property developers holding sizable offshore debt might find it harder to make payments if the yuan drops in a big way.
Part of the weaker yuan argument revolves around China’s obsession with annual growth targets. It’s become a particular distraction since the 2008-2009 Lehman Brothers crisis era.
Since then, China’s growth model has relied heavily on municipal leaders around the nation ordering up huge projects: six-lane highways; monorails; international airports; stadiums; conference and shopping centers; city hall complexes; corporate campus districts; five-star hotels; massive museums.
For local government leaders, making China’s annual numbers has dominated the economic incentive structure. The quickest way for an ambitious local powerbroker to get Beijing’s attention is by routinely turning in above-average GDP rates.
When Xi rose to power in 2012, he pledged to let market forces play a “decisive” role in economic policymaking. To prove it, Beijing spent the last five years working to reduce leverage in the financial system and curb risks among property developers. But the GDP target runs at cross purposes with that priority.
The problem, argues Thomas Helbling, deputy director of the International Monetary Fund’s Asia-Pacific unit, is that “the economy is very investment heavy.”
The IMF cites the property crisis along with falling global demand as the biggest headwinds zooming China’s way. Yet, so is a growth model that encourages unproductive borrowing.
Beijing, Helbling says, must level the playing field for private businesses to compete with state-owned enterprises. It must build a strong social safety net to encourage consumption and increase investments in education and technology to increase productivity. Pension reforms are also crucial to dealing with China’s aging population.
“If you do those reforms, there is an upside to growth,” Helbling concludes.
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