The Long Shadow of China’s Fiscal Expansion

Abstract

In 2009 and 2010, China undertook a fiscal stimulus program worth 4 trillion yuan, roughly equivalent to 11 percent of its annual GDP.This program was largely financed by off-balance-sheet companies-known as local financing vehicles-that both borrowed and spent on behalf of local governments.These companies have continued to grow since the stimulus program concluded at the end of 2010; their spending has accounted for roughly 10 percent of GDP each year, with an increasing share used for what are essentially commercial projects.And their spending has likely been responsible for an increase of 5 percentage points in the aggregate investment rate and for part of the decline of 7 to 8 percentage points in the current account surplus since 2008.We argue that local governments have used their new access to financial resources to facilitate favored businesses' access to capital, which potentially worsens the overall efficiency of capital allocation.The long-run effect of offbalance-sheet spending by local governments may be a permanent decline in the growth rate of aggregate productivity and GDP.1.The figure shows the combined budget deficit of the central and local governments.7. These numbers are from Feng, Hu, and Moffitt's (2015) tabulations from the Urban Household Survey.8. On the monetary policy side, the required reserve ratio was adjusted downward three times in the fourth quarter of 2008, down from 17.5 to 16 percent and from 16.5 to 13.5 percent for large and small financial institutions, respectively.The official benchmark interest rates were cut four times in that period.The one-year deposit and loan rates, for instance, dropped from 4.14 percent and 7.2 percent to 2.25 percent and 5.31 percent, respectively.9. We exclude the subitems in each category that should not be counted as investment.