China's property downturn continues to drag down government spending

China’s economic slump should call for the government to make up for lagging demand with an expansionary fiscal policy. But the latest data out of China indicates that the Chinese government’s fiscal spending as a share of GDP appears to have dropped again in 2023, continuing a decline that started in 2021. Behind that drop was China’s property sector turmoil, which sharply curtailed a key source of revenue that local governments depend on for their spending.

Fiscal spending in China is urgently needed because the Chinese economy is facing increasing deflationary pressure and weak private demand. Chinese local governments draw a significant portion of their fiscal revenue from selling use rights of state-owned land to property developers. But as indicated most recently by the Evergrande Group’s liquidation, many property developers continue to struggle with their internal financial crises, resulting in a falloff in local governments’ land sale revenue in 2023 to RMB 5.8 trillion, 13 percent lower than 2022 and the second consecutive yearly decline.[1] Compared with the peak in 2021 of RMB 8.7 trillion, land sale revenue in 2023 was about one third lower. That said, a mild recovery in land sales occurred in late 2023. In December 2023, land sale revenue grew 1.8 percent in year-over-year terms, the first time the monthly growth turned positive since early 2022.

How did the drop in land sale revenue impact government spending?

With the drop in land sale revenue, the Government Funds Budget, in which local governments keep land sale revenue for spending related to land and infrastructure development, saw its spending fall by 8.4 percent from 2022. That is largely because local authorities spend most of their land sale revenue on areas closely associated with land sale activity, including resettlement compensation, land development, and other costs. When less land is sold, these expenditures suffer.[2]

Yet combined spending in the Government Funds Budget, the General Public Budget (which draws most revenue from taxes) and the State Capital Operation Budget (which draws revenue from dividend payments from state-controlled enterprises) went up slightly by 1.2 percent in 2023 from 2022, largely driven by a 5.4 percent increase in the General Public Budget spending.[3] The Chinese government also runs a Social Insurance Budget, which draws revenue from social insurance payments and fiscal subsidies from other budgets for social security outlays. But its revenue and spending data will not become publicly available until the Ministry of Finance’s budget report is submitted to the National People’s Congress in March 2024.

Assuming that Social Insurance Budget revenue and spending are the same as their budget levels, China’s consolidated fiscal spending would have risen slightly by 2.3 percent in 2023.[4] But that increase would have failed to catch up with China’s output growth, and the consolidated spending in GDP share in 2023 likely dropped by 0.8 percentage point of GDP from 2022, continuing a decline that started in 2021 (see figure below). This suggests that fiscal spending failed to provide adequate support to China’s recovery following its zero-COVID reopening.

What should China do?

To start with, China needs to make more realistic projections of land sale revenue in its government budgets. In the 2023 budget, the Government Funds Budget revenue, in which over 80 percent is usually land sale revenue, was projected to reach a level similar to that of 2022 (see table below), probably because Beijing was expecting that its rescue plan in the property sector would help revive the nation’s land sale market. But that was overly optimistic. Given budget spending in the Government Funds Budget is largely determined by revenue projection, due to the fiscal principle “spending according to revenue” mandated in China’s Budget Law, a lower-than-expected land sale revenue in 2023 eventually led actual spending to fall short. The property downturn is likely to last for years, a long overdue correction in a sector at overcapacity. Sustained low land sale revenue will likely become the norm for local governments.

But that alone is not enough. China also needs to raise planned spending in areas outside of land and infrastructure development at the same time in its government budgets to make up for the potential decline in spending caused by fewer land sales. And during this process, more revenue needs to be raised and/or more debt needs to be issued to make up for the potential financing gap. Given China is already facing diminishing returns from its outsize investment in infrastructure construction,[5] it should consider allocating more fiscal resources to provide more direct support for households, strengthen the social safety net, and develop human capital. Doing so would yield long-term benefits for its economy. China’s population is embarking upon an almost irreversible path of long-term decline.[6] It is only sensible for it to invest more in its own people.

China managed to achieve its growth target and grew at 5.2 percent in real terms in 2023, but its nominal growth was only 4.6 percent. This means the GDP deflator, a broad measure of economy-wide inflation, was negative. If prices continue to fall, consumers and businesses will likely put off buying and investing in anticipation of further price drops. A deflationary spiral is detrimental to an economy. At this critical juncture, fiscal policy needs to be more expansionary to help arm China’s fight against falling prices.

Notes

1. See “Report on Fiscal Revenue and Spending in 2023,” Ministry of Finance of China (in Chinese), February 1, 2024 (accessed on February 1, 2024).

2. The remaining funds are spent on infrastructure, agriculture, public housing, and other areas that are less directly associated with land sales. 

3. It is still unknown at this point how much of the RMB 1 trillion additional sovereign bond China issued in late 2023 has already been spent. But given the actual General Public Budget spending is roughly the same as the budget level, it is likely the additional sovereign bond had not been spent yet by end 2023.

4. This assumed percent increase is calculated as the fiscal spending under all four budgets combined with fiscal subsidies from other budgets removed in the Social Insurance Budget to adjust for double counting.

5. See Kenneth Rogoff and Yuanchen Yang’s working paper “Rethinking China’s Growth,” available at https://scholar.harvard.edu/rogoff/publications/rethinking-chinas-growth (accessed on January 30, 2024).

6. See Jacob Fund Kirkegaard, “China’s population decline is getting close to irreversible,” PIIE Charts, January 18, 2024, available at https://www.piie.com/research/piie-charts/2024/chinas-population-decline-getting-close-irreversible (accessed on January 28, 2024).