A primer on China’s fiscal position: Worsening but with less off-balance sheet financing

• China's fiscal position is mysterious but an important concept for investors. In this note, we aim to offer a) an overview of China’s fiscal position based on the consolidation of four government accounting books, including the on and off-balance sheet items; and b) an estimate of fiscal deficit in 2018 and compare with the years before.
• To start with, there are a few problems with using official data to measure China’s fiscal deficit. First, the officially reported headline fiscal deficit only includes the general budget balance, but not the other three accounting books, namely the Government Fund, the Social Security Fund, and the State-Owned Enterprise Fund. Second, local government financial vehicles (LGFVs) are not included in any of the above. While the officially reported fiscal deficit has widened to -4.2% in 2018, the largest since 1990s, we find a larger actual deficit.
• The on-balance sheet budget deficit (composed of the total four fiscal accounts) has reached 5% in 2018, from 3.9% in 2017.
• The bulk of the widening deficit can be found in the larger and better known account, namely the general budget, due to faster expenditure and, to a lesser extent, less fiscal revenue, especially in the second half of 2018.
• The second largest on-balance sheet item, namely the government fund (related to local government infrastructure), has experienced a very large deterioration, for its size, as it has run a 0.6% deficit from a balanced position before. The social security account has remained slightly negative and is expected to worsen with population aging. Together with the SOE fund, the three other fiscal accounts offers an additional -0.8% of GDP to China’s fiscal deficit. This explains the overall 5% on-balance sheet deficit, which deteriorates faster than the official general budget figures.
• The lion share of China’s off-balance sheet fiscal liabilities originated from LGFVs borrowing. The clamp-down on illegal local government financing (i.e., LGFVs), and more generally, shadow banking since 2017, has resulted in relatively smaller off-balance sheet deficit, but still hovering around -2.9% of GDP in 2018.
• All in all, China’s aggregate fiscal deficit in 2018 has reached 7.9%, from 7.3% in 2017. The worsening of both the on-balance sheet (narrow definition including four budget accounts) and the aggregate (broad definition further including LGFVs) deficit do not bode well for China’s fiscal sustainability. That said, because the fiscal expansion in the second half of 2018 did not stem off the rapid economic deceleration, we should expect an even larger fiscal stimulus in 2019.

Full report available for NATIXIS clients.