Time for Beijing to trim treasury bonds

Yang Ping & Liu Lifeng The China Daily Asia News Network Beijing

Judging from the nation's position in its economic cycle, now is the time for the Chinese authorities to cut down the scale of investment funded by treasury bonds.

Diminishing government investment at the proper time will reduce the amount of credit granted by commercial banks for urban construction and real estate development, which is held by many as a source of overheating in some industries.

It will also write off the over-demand for production materials and investment targets.

As a matter of fact, government investment is not as strong as it used to be. The percentage of fiscal deficit in gross fiscal spending was as high as 15.7 percent in 2000, but the proportion has since been on an overall decline, indicating a weakening role of the pro-active fiscal policy in the economy.

The same trend could be seen from changes in the percentage of long-term construction treasury bonds in the fiscal deficit.

In 1998 when the government initiated its investment drive using treasury bond funds, the size of the fiscal deficit was identical with that of long-term construction treasury bonds. In the next three years, long-term treasury bonds accounted for about 60 percent of the fiscal deficit. The rate went down to 48.4 percent last year and is predicted to be 43.7 percent this year.

The continual drop of this rate indicates the government is cutting down the treasury bond investment. Another sign of a cooling-off in government investment is that long-term construction treasury bonds are taking a lower ratio in total bond issuance in recent years.

Therefore, it is safe to say China's economic development, especially the boom this year, has been achieved against the backdrop of a shrinking government investment fund.

According to mainstream theories on public finance and macro economy, the fiscal policy should be adjusted along with the change in real economic conditions. When the economy is growing at a slower pace than its potential, fiscal policy should be expansionary to stimulate the economy. But when economic growth recovers, fiscal policy should switch from being pro-active to neutral and the fiscal deficit should be gradually cut down.

China will pick up its potential growth this year and it is predicted to maintain a high annual growth of 9 percent in the coming years. Under these conditions, fiscal policy, which has focused on the expansion of treasury bond investment, has accomplished its mission.

Moreover, there is always a time lag between a policy switch and it taking effect. Fiscal policy should be changed a bit earlier to leave a necessary buffer period to avoid dramatic ups and downs in the economy.

The time is now ripe to phase out the expansionary investment mode boosted by treasury bonds. Considering the investment demand from projects under construction, the authorities should continue to issue long-term construction treasury bonds in 2004-2005, but the amount should be cut down gradually to ensure the smooth phase-out of the policy by 2006.

The funding gap arising from increased demand for developing the western region and promoting rural education and healthcare will be filled through adjusting the structure of budgetary expenditure.

Such a policy adjustment will not hold back economic growth. In the first half of this year, investments by collective and individual investors were up by 34 and 24.3 percent respectively, registering notable growth over last year. Investment by shareholding and foreign enterprises also grew remarkably during the same period.

It indicates that non-state investments are entering a fast track. The investment capital structure has changed remarkably and the economy no longer depends as heavily on treasury bond investments as it used to.

Therefore, the gradual reduction in treasury bond investment will not have a negative impact on the current growth momentum. Instead, it will cool down overheated investment in such industries as real estate, metallurgy and non-ferrous metal industries.

With those industries registering fast growth records in recent years, banks have been passionate in granting unsecured credit, which has contributed to excessive investments in those industries, and has also led to increased debt risks for banks and local governments.

Gradually withdrawing the treasury bonds can help cool the investment fever in those sectors and protect banks from being trapped in a new round of bad loans.

Last but not least, the gradual phase-out of the treasury bond policy will help ease inflation pressure.

The writers are researchers with the Research Institute of Macro Economy under the State Development and Reform Commission.