China fiscal outlook: Persistently high deficits, rising debt drive rating pressures

May 21, 2024 (MLN): China’s fiscal policy is turning slightly stimulatory, as the government seeks to offset subdued underlying economic activity and achieve its GDP growth target of “around 5%”. Fitch Ratings forecasts the general government deficit at 7.1% of GDP in 2024, from 5.8%.

The high deficit will push the government debt ratio to 61.3% of GDP by end-2024 – 23pp above the 2019 level, the largest increase among major economies. This comes as fiscal deficits have averaged 6.4% since 2020, about double the 2015-2019 average of 3.1%.

The deterioration has primarily been revenue-driven, with revenue as a share of GDP falling from about 30% in 2018 to around 23%. Tax cuts since 2018 have weighed on revenue collection. The sharp property correction has exacerbated these dynamics by constraining local government revenue.

Even as explicit government debt is still in line with rating peers, we view fiscal risks as higher than suggested by this metric, given perceptions that certain entities carry implicit government support.

The stock of local government financing vehicle (LGFV) debt is large, with growing risks that this debt could crystallise on to local government balance sheets, although we still see such a migration as only gradual.

Fitch believes medium-term deficit reduction will be gradual as the government seeks to achieve growth priorities amid transition away from the property sector.

This deficit outlook, with lower nominal GDP growth, keeps the debt ratio trending upward to around 70% by 2028, with the central government playing a larger fiscal role.

Fitch revised the Outlook on China’s ‘A+’ sovereign rating to Negative in April 2024, to reflect the growing pressures on public finance metrics. The medium-term trajectory of the government debt-to-GDP ratio is our key upward and downward rating sensitivities.

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