China's Borrowing Buys Time For Economic Growth

An analysis by Michael Lelyveld
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china-bank-of-beijing-branch-feb2-2010.jpg Pedestrians walk past a branch of the Bank of Beijing in China's capital Beijing in a file photo.

China narrowly avoided a drop in its economic results for the first quarter with a record surge in bank loans following complaints from small businesses that tax cuts provided little relief.

Last week, officials hailed the government's economic efforts as the National Bureau of Statistics (NBS) announced that gross domestic product rose at a 6.4-percent rate. The result matched the growth of last year's fourth quarter, but fell short of the full-year 2018 pace of 6.6 percent.

The economy "enjoyed stable performance with growing positive factors and stronger market expectation and confidence," the NBS said in its press release.

By beating consensus forecasts of 6.3 percent for the period, the official figures remained within the upper part of the government's target range of 6 percent-6.5 percent GDP growth for this year.

A variety of reports suggested a "rebound," "renewed signs of life" and a bottoming out of declining growth rates this year.

But the official reports illustrated how easily China's economic outlook could be decimated by a decimal point.

Hours before the NBS announcement, Reuters reported that China's anticipated growth was expected to record "its weakest pace in at least 27 years," raising concerns of a sharper drop and job losses this year.

Even after the official numbers came out, the London-based Financial Times wrote that "the country is facing its slowest rate of economic growth in 30 years."

Some analysts have dismissed the official figures entirely.

"The Chinese published GDP numbers are absolute garbage," said Leland Miller, CEO of the China Beige Book advisory firm, CNN Business reported, citing remarks made in February.

"It's certainly the consensus that these numbers are unreliable."

For the time being, the forecast-beating figures helped the government win the battle for headlines, which is all that stock markets normally have time for. The benchmark Shanghai Composite Index closed slightly higher on the announcement, gaining 0.29 percent.

Government slashes VAT

But behind the official figures and the skepticism, there remained concern over China's economic policies and GDP growth defenses.

The big question in the weeks before the quarterly results became public was whether economic policymakers had turned over a new leaf.

After years of pumping up GDP with stimulus from bank loans and debt, the government has tried turning to tax cuts to spur consumption growth.

On April 1, the government slashed its value-added tax (VAT) rate for manufacturing to 13 percent from 16 percent and trimmed the VAT for transportation, construction, and other industries to 9 percent from 10 percent.

The VAT cuts were the largest part of a 2-trillion yuan (U.S. $297.7 billion) package of reductions in taxes, fees and corporate social security payments as the government sought to ease business burdens and slow the economic slide.

The incentives took effect quickly after Premier Li Keqiang unveiled them in his work report to China's annual legislative sessions on March 5, conveying urgency over the economy's decline. All the cuts were larger than expected, the South China Morning Post said.

The fiscal steps won favorable reviews from some economists after years of warnings over loose lending and rising debt.

Gary Hufbauer, nonresident senior fellow at the Peterson Institute for International Economics in Washington, said earlier this month that the cuts would provide "significant support" to the economy, with a stimulus equal to 2 percent of GDP.

"The impact would have been greater if the same revenue cuts had been made in corporate taxes, but still the impact should be meaningful," Hufbauer said.

Income tax cuts

The business breaks followed cuts of up to 50 percent in personal income taxes for mostly middle and lower-income wage earners that began last October.

Both batches of benefits were aimed at boosting consumption after the steady erosion of retail sales growth, which fell 1.2 percentage points to 9 percent last year.

Growth of 8.1 percent in November was the lowest in over 15 years, The Wall Street Journal said.

According to official data, consumption accounted for 76.2 percent of China's economic growth last year. Despite the NBS insistence that consumption remained the "dominant driving force," its reported contribution fell to 65.1 percent in the first quarter of this year.

At the start of 2019, retail sales did not do much better, despite last year's tax cuts. The NBS recorded growth of 8.2 percent for the first two months of the year. Stronger activity in March boosted first quarter growth to 8.5 percent, but the level still fell below last year's rate.

The size of this year's tax package, following last year's 1.3 trillion yuan (U.S. $193.5 billion) worth of breaks, raised the question of whether it would have a major impact on economic growth.

Record lending by banks of 5.8 trillion yuan (U.S. $864.8 billion) in the first quarter appears to reflect government doubts that tax cuts by themselves would be enough to stop the decline.

The tax reductions planned for this year are roughly equal to 62 percent of the new yuan-denominated loans issued by China's banks in January alone.

The huge volume of loans in the first quarter exceeded Switzerland's GDP, Reuters said. New lending during the period soared 19.3 percent from a year before, according to official data from 2018.

A Chinese man closes his small shop in Shenyang, northeastern China's Liaoning province, July 4, 2017.
A Chinese man closes his small shop in Shenyang, northeastern China's Liaoning province, July 4, 2017.
Credit: AFP
Not a solution

Some economists say the VAT strategy is not a solution for China's economic growth problem in any case.

"We have no evidence of tax cuts ever stimulating the Chinese economy," said Derek Scissors, a resident scholar at the American Enterprise Institute in Washington.

"What will boost the economy is fewer state firms, which absorb capital but do not generate economic growth," Scissors said.

Reports suggested that the benefits of VAT cuts will not be distributed evenly.

In a March 20 report, the South China Morning Post interviewed a series of officials at small and medium-sized enterprises (SMEs) who expect little benefit from the breaks.

"Those boasting that these policy tax cuts are unprecedented and sufficient, I bet they have never been a boss of a small factory like ours," one business owner said.

A common complaint among struggling SMEs is that their margins are too small to give them much of a boost from the VAT cuts.

"For those enterprises with annual output valued at more than 50 million [yuan] (U.S. $7.4 million), the VAT tax cuts should have certain economic value, but for us, as small-sized enterprise producing grain and oil processing equipment, it helps little," another business operator told The Post.

SMEs and privately-owned companies have been more concerned about problems with high costs and limited access to loans as banks continue to favor lending to state-owned enterprises (SOEs).

The government appears to be responding gradually to SME complaints.

On April 7, the Communist Party of China (CPC) Central Committee and the cabinet-level State Council jointly issued a guideline that "called for more attention to the problems impeding further growth of SMEs," the official Xinhua news agency reported.

Two days later, Xinhua said the government plans to help SMEs by "facilitating their direct financing in the capital market," including fast-tracking initial public offerings (IPOs).

But no mention was made of bank lending problems or the low SME benefits from VAT breaks.

On April 17 at a State Council meeting, Premier Li addressed the issue, setting a target to increase state bank loan approvals to micro and small-sized enterprises by 30 percent this year, the official English-language China Daily said.

Steelmakers pocket VAT savings

Concerns about the inadequacy of the tax cuts have not been limited to SMEs.

China's steel producers also say their margins are too small to pass the savings on in the form of reduced product prices, leaving the intended impact on economic growth in doubt.

A commentary by the industry website on March 19 said the VAT cuts "will surely help the domestic manufacturers to better weather the slowdown in the national economic growth," but that would be "no guarantee to lower prices."

"Lower tax ... does not necessarily lead to lower prices in the industrial products, though it provides more room for the manufacturers ... when the market situation calls for such moves," it said.

In other words, China's steelmakers are inclined to pocket the VAT savings instead of passing them on to customers like automobile manufacturers, who could then lower car prices to revive slumping sales and help to raise GDP.

In the first two months of the year, steel industry profits plunged 49.5 percent from a year earlier, according to the National Development and Reform Commission (NDRC), the government's top planning agency.

Last year, car sales fell 2.76 percent after decades of growth, according to the China Association of Automobile Manufacturers. Sales lost 4 percent in January, 18.5 percent in February and 12 percent in March, Bloomberg News said, citing the China Passenger Car Association.

"The slowdown in auto sales was the main contributor to weaker consumption growth last year," an NDRC official said in January.

But the poor profits in the steel industry may block the pass-through of VAT savings to car makers and consumers.

"In the end, it depends on how high the profit margin is for each particular sector, as for steel mills, the margin is so thin for the time being that there is no way for us to reduce our steel prices to fully or even partially reflect (the) three percentage-point difference," said a steel mill official cited by

On April 1, Xinhua reported that several foreign makers of consumer products, including car companies, had reduced retail prices in anticipation of the tax cuts.

But the reactions of the SMEs and steel producers seem likely to limit the effect on GDP, persuading the government to keep turning over the old leaf of boosting the economy with more bank loans.

"Cutting taxes now, while borrowing is expanding, suggests the central government doesn't think tax cuts will work, either," Scissors said.


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