How Fiscal Reforms Could Affect the Economy

Investment Rating - The report does not explicitly state an investment rating for the industry Core Insights - The report discusses the need for fiscal reforms in China to address local government funding pressures and the challenges posed by debt, demographics, and deflation [2][4][9] - It outlines a five-year reform plan aimed at rebalancing central-local fiscal relations and increasing revenue sources for local governments [3][19] - The report presents three scenarios (base case, bull case, bear case) regarding the potential economic impacts of these reforms [31][40][42] Summary by Sections Fiscal Challenges - Local governments in China are responsible for over 85% of fiscal spending but face significant funding constraints due to a structural housing downturn and a 40% decline in land sales [2][9] - The augmented fiscal deficit has narrowed by 6 percentage points to 11.1% of GDP over the past two years [9][13] Proposed Reforms - Key measures in the reform plan include increasing central government spending responsibilities, allowing more flexible use of local government special bonds (LGSB), raising local governments' share in shared taxes, and expanding local tax sources [3][19][21] - The central government has allocated Rmb300 billion in ultra-long special treasury bonds to support economic initiatives [19] Economic Scenarios - Base Case: Real GDP growth is expected to remain subdued at 4.8% in 2024 and 4.5% in 2025, with a GDP deflator projected to rise from -0.5% to 0.2% [4][31] - Bull Case: A Rmb10 trillion stimulus could boost real GDP growth to 5% in 2024 and 5.2% in 2025, with the GDP deflator turning positive [5][40] - Bear Case: Premature tax hikes could lead to a decline in real GDP growth to 4.3% in 2024 and 3.2% in 2025, with the GDP deflator falling to -1% and -2% [5][42] Local Government Revenue - Local governments have increased the collection of non-tax revenues to address funding gaps, which may exacerbate deflationary pressures [10][18] - The report highlights the need for reforms in consumption tax to improve local government fiscal conditions, although the effectiveness of such reforms remains uncertain [48][51]