"China has no choice but to increase debt levels"
Beijing needs to "destroy its existing fiscal concepts," says top economist.
A leading Chinese economist has called for Beijing to accept higher debt levels over the long-term, as part of a profound transformation of its attitudes towards debt-fuelled fiscal policy.
Luo Zhiheng (罗志恒) believes China needs to further extend the current cycle of expansionary fiscal stimulus that first kicked off in the wake of the Global Financial Crisis nearly two decades ago.
China's fiscal policy has been expansionary since the GFC
Luo, chief macroeconomic researcher at the Yuekai Securities Research Institute, argues that China's fiscal policy has continuously remained in an expansionary state for the past 17 years.
In a recent opinion piece (“罗志恒：“十五五”时期中国财政政策展望，财政政策转型的必要性与可能路径”), he writes that the current cycle began when Beijing launched its four trillion yuan stimulus package to deal with the Global Financial Crisis (GFC).
This consisted primarily of supply-side measures - expansions to government spending and structured reductions to tax rates, which enabled China to keep economic growth at an average per annum rate of 9.9%.
Even after the direct impacts of the GFC abated, however, Beijing never fully took its foot off the pedal of fiscal policy during the subsequent decade.
The outbreak of the Covid pandemic in 2020 forced China to step up fiscal policy measures to keep economic growth afloat.
This time the focus was on large-scale reductions to taxes and administrative fees, to reduce the burden on private business and Chinese households.
Luo says these measures enabled the Chinese economy to maintain average per annum growth of 4.7% during the period from 2020 - 2023, as compared to a global growth rate of just 2.3%.
Fiscal policy needs to adjust to new challenges
Far-reaching changes to the Chinese economy mean that the types of fiscal policy implemented in the past may no longer prove so beneficial in future.
Tax and fee cuts have been the mainstay of China's expansionary fiscal policy for over a decade. The marginal effectiveness of such measures is gradually declining, however, after running their initial course.
Luo points out that while these cuts lighten the cash flow pressures of businesses and households, it's hard for this to translate into investment or spending that primes the economy whenever overall confidence remains weak.
This is likely the case in China at present, with households and businesses still yet to fully recover from the property slump, and inflation languishing at anaemic levels.
In addition to being of limited effectiveness at present, large-scale tax cuts also have the negative impact of increasing the Chinese government's debt ratio, by dialling down its fiscal revenues.
In 2024, China's national regular public budget revenues dropped to 16.3% of GDP, for a decline of 5.1 percentage points from 2013.
"Further declines may not be of benefit to national macro-economic adjustments and national fiscal security," Luo writes.
"As the inelasticity of fiscal expenditures rises, and it becomes difficult to implement large-scale cuts and reductions, declines in revenue will lead to increases in government debt.
"With limits on growth in the denominator of the overall economy, government debt ratios will rise."
China still has no choice but to increase debt
Despite this, Luo argues that China still needs to maintain expansionary fiscal policy to keep economic growth steady, as consumption demand remains weak and geopolitical uncertainties further worsen.
"Domestic and external factors - including a declining population, a slow down in urbanisation and rises in global trade frictions, will constrain economic development," Luo writes.
"The most urgent mission at present is still to maintain economic stability - in particular, to achieve a rebalancing of supply-demand relations by driving domestic demand."
As a consequence, Luo says China’s policymakers have no choice but to accept a rise in government debt levels.
He believes Beijing needs to change established practices - if not its entire mindset, when it comes to fiscal policy, in order to accommodate this unavoidable rise in China's leverage.
"As economic growth eases and it becomes difficult to increase fiscal revenues, we must maintain a certain level of active fiscal policy," Luo writes.
"This will require greater debt issuance to raise funds, which in turns means destroying existing fiscal concepts."
The chief change here will be a shift from "balanced fiscal policy" (平衡财政) towards "functional fiscal policy" (功能财政).
A key goal will be shoring up the acceptability of China’s official deficit ratio rising above the longstanding 3% ceiling.
This already happened in 2025, with Beijing announcing at the Two Sessions congressional event in March that the deficit ratio for the year would be set at 4%.
"Effective fiscal policy should not be subject to a 3% deficit ratio limit," Luo writes.
"One of the fundamental functions of fiscal policy is to play a counter-cyclical role in order to maintain economic stability.
"In the short-term, raising the deficit ratio helps to more rapidly drive economic recovery, and prevent drags on medium and long-term growth."
Luo points to the example of advanced economies as justification for setting China's deficit ratio at a higher threshold.
"Breaking through the 3% deficit ratio isn't abandoning fiscal discipline,” he writes.
“The US and EU have broken through this barrier on multiple occasions when dealing with domestic and external economic volatility.
"The deficit ratio for the US was on average as high as 10.9% during the pandemic (2020 - 2022) financial years."