A new paper from the International Monetary Fund concludes that credit stimulus is no longer capable of supporting further growth of the Chinese economy.
The IMF working paper entitled “Credit and Fiscal Multipliers in China” by Sophia Chen, Lev Ratnovski and Pi-Han Tsai made use of an “instrumental variables” approach to assess the impact of credit upon output growth in China since the turn of the century.
According to the paper credit proved effective at shoring up Chinese output growth during the first decade of the 21st century, with China’s GDP increasing by 2% in response to a 10-percentage point shift in the ratio of credit to initial GDP during the period from 2001 to 2008.
This figure has fallen to nearly zero since the turn of the decade, however, with researchers speculating that the plunge is the result of credit saturation in the wake of the Great Financial Crisis, leading to inefficient credit allocation to areas such as the housing market, state-owned enterprises or local government financing vehicles.
In sharp contrast China’s fiscal multiplier rose from 0.7 during the period from 2001 – 2008 to 1.4 for the period from 2009 – 2015, meaning that GDP increased by 1.4 percent following a 1-percentage point change in the ratio of on-budget expenditure to initial GDP.
For this reason the researchers conclude that fiscal policy will still prove an effective growth support should the Chinese economy meet with any shocks in future, such as reduced credit expansion.
Domestic and external observers have long expressed concerns about China’s burgeoning debt levels, which prompted both Moody’s and S&P’s to downgrade the country’s sovereign credit ratings in 2017.
China’s top policymakers launched a much-vaunted deleveraging campaign in 2017, with the goal of dialling down the huge debt burden accumulated in the wake of the Great Financial Crisis.
While the recent IMF paper would advocate more fiscal as opposed to credit stimulus given its conclusions about their respective levels of effectiveness, the researchers make the caveat that credit allocation is relevant, and advocate that China continue to extend “prudent credit” to efficient firms that are capable of supporting economic growth.
The research also points out that priorities matter when it comes to fiscal stimulus, and China should now shift from targeting infrastructure and manufacturing-related expenditures towards social expenditures and transfers, in order to expedite the transition of the Chinese economy towards services.