The Junction of China’s Welfare Spending and Fiscal Sustainability

Debt levels in China are believed to be sustainable at a national level, but a closer look at provincial level data, flags up potential causes for concern.

Prior to the Global Financial Crisis, there was a consensus that China was fiscally sustainable with both foreign and domestic debt taken into consideration. This is because the nation had enough foreign exchange reserves and government assets to cover the debt. However, in the decade following the crisis, China’s central government debt rose from 27% of GDP in 2008, to 47% in 2017. This surpasses the sustainable debt ratio of 40% for developing countries, as outlined by the International Monetary Fund (2002).

While many researchers are convinced that this level is manageable for China, ACI research delves into an analysis of provincial debt levels, highlighting that China’s provinces have a debt to GDP ratio ranging from 13.2% to 97%.

The research emphasizes that the broad picture at the national level does not portray the complexity and diversity of debt at the provincial level. It is crucial to acknowledge that local governments have their unique budget conditions and welfare spending capacities. Insufficient revenues, stringent debt control, and vast developmental needs are key factors that make local governments seek capital in indirect methods, which results in countless off-budgetary activities and off-balance sheet liabilities.

The recent paper by ACI researchers examines the junction of the latest debt-trend coefficients and social expenditure ratios across provinces. They find that welfare expenditure is a driver to the build-up of unsustainable provincial debt levels, which signals a need for more careful formulation of welfare policies in the future. Provided the intricacies of Mainland China’s fiscal system, as well as the additional complicated layer of the interaction between central and provincial governments, it is an onerous task for the provincial government to maintain fiscal sustainability while considering the ongoing improvement of social welfare.

Looking beyond China, this is a useful lesson for other ASEAN emerging markets as well. The ASEAN economies typically have low debt ratios and observe statutory limits on the size of public debt. The policy lesson to be learned is that although the majority of ASEAN governments are primarily focused on infrastructure development, social welfare demands are increasing. As such, we tend to see that political parties often use welfare promises to garner votes at general elections. However, welfare programs are difficult to dismantle in the short term when countries are faced with debt issues. Therefore, the long-term sustainability of welfare programs needs to be cautiously assessed prior to implementation, with the junction of welfare spending and fiscal sustainability in mind.

by Sunena GUPTA

Researchers: Tilak ABHEYSINGHE, Mao KE, Xuyao ZHANG

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