IMF wants China to spend its way out of the 'fiscal cliff'

Governments from Washington to Brussels are being told to spend less, but Beijing is being urged to spend more.

At the International Monetary Fund and World Bank meetings in Bangkok earlier this month, Managing Director Kristalina Georgieva called the U.S. and European countries the "worst offenders" on debt and boiled down her prescription: "China needs to spend more, the U.S. has to save more, and Europe has to invest more."

Georgieva also urged Beijing to deliver more meaningful fiscal stimulus as its economy teeters on deflation, expecting China's economic growth to slow to 4.5% this year from 5% last year, and slow further to 4% in 2027.

Beijing has space to borrow, with general government debt at about 68.4% of GDP, according to the IMF. But a debt crisis looms outside the government's balance sheet. The augmented government debt, including local government financing vehicles and off-balance sheet borrowing, ballooned to around 126.6% of GDP last year, IMF estimates, comparable to developed markets including the U.S. and Europe.

Local authorities, for decades, relied on selling land to developers to fund development of roads, rail lines and industrial parks. That income has collapsed since the property slump began in 2021. Beijing has since moved to stop local governments from piling up new hidden debt, curbing the off-the-books borrowing, removing a key engine of growth.

CF40, a Beijing think tank that co-hosted last week's Bund Summit in Shanghai, estimates that land-sale income has more than halved since 2021, to 4.2 trillion yuan, equivalent to about $590 billion, from 8.7 trillion yuan.

That squeeze has fed through to spending. Combined fiscal spending declined 3.5% in the first eight months of the year, after growing 3.6% last year, Ting Lu, chief China economist at Nomura, estimates, describing it as a "true fiscal cliff" that has become a real drag on the economy.

Urban fixed-asset investment declined for the first time in decades, falling 3.8% last year, and has since steepened its decline, dropping 7.2% in the first three quarters. Beijing held its official deficit target at about 4% of GDP, but the Institute of International Finance estimates the actual deficit could reach as much as 9% and says even that looks insufficient.

Beijing has ordered the state-backed borrowers to clear hidden debt and transition into market-oriented commercial state-owned enterprises by mid-2027. Hidden debt in such vehicles shrank to 6.5 trillion yuan ($973.3 billion) last year from 14.3 trillion yuan in 2023, according to S&P Global Ratings. But many of the vehicles still lack the cash flow to pay interest and remain burdened with unprofitable public projects, S&P said.

The IMF wants Beijing to square the circle with a medium-term fiscal framework, one that lets China "expand fiscally in the near-term [to reflate the economy] but claw back the support over the medium term so that you ensure debt sustainability," said Krishna Srinivasan, director of the fund's Asia and Pacific department.

The fund also urges China to move away from point growth targets, which it says push local officials to invest excessively to hit the number, leading to resource "misallocation" and rising provincial debt.

Stakes are high as letting any local government default could set a dangerous precedent. "No one wants to be the first local government official to default," said Logan Wright, partner at Rhodium Group. But once one does, and Beijing steps in, the rest can expect the same bailout, he said, meaning local officials' priorities may sometimes run counter to Beijing's. "They actually want to default."