China’s Fiscal Dilemma
The Chinese government is likely to face a tricky economic policy choice in the second half of this year. If it loosens its fiscal stance, public finances will worsen significantly. But if it cuts expenditure to offset the pandemic-related revenue shortfall, growth will be lower, with dire consequences.
BEIJING – COVID-19 hit the Chinese economy hard in the first quarter of 2020, causing real GDP to contract by 6.8% year on year. But since the city of Wuhan emerged from lockdown in early April, the economy has gradually returned to normal, and grew by 3.2% in the second quarter. According to the consensus view, China’s current potential GDP growth rate is 6%. If it achieves this in the second half of 2020, the economy could post full-year annual growth of 2.5%.
But achieving this outcome will require a demand boost. Lack of effective demand has impeded China’s growth for years, and the pandemic has made the situation much worse.
Consumption, which accounts for 55% of China’s GDP, fell by 3.9% in terms of social retail sales in the second quarter, on top of a 19% decline in the first three months of 2020. Some argue that consumption will now surge and become the main growth driver in the remainder of the year. But this is unlikely, because households will be anxious to replenish the savings they depleted during the lockdown. The government can and should provide relief to households affected by COVID-19, but it cannot do much to stimulate consumption.