ON FISCAL POLICY TRANSITION

by Jia Kang, Director, Research Institute for Fiscal Science, Ministry of Finance, and Zhao Quanhou

The Central Economic Working Conference concluded in December 2004 established the cornerstones for China's macro economic adjustment in the immediate future: sound fiscal and monetary policy. This indicates that China's fiscal policy is experiencing an important transitional period after the predominance of proactive fiscal policy for the past six years.

The transition in fiscal policy is necessary for a few reasons. A proactive fiscal policy, if carried out during a period of the national economy that is overheating and in a cyclical shift, could undermine control over excessively rapid growth in fixed asset investment and may not alleviate inflationary pressure; with the tendency of system reversion due to the long-term implementation of proactive fiscal policy, a potential continual expansion of treasury bond investment may increase the difficulty of macro economic adjustment; and years of proactive fiscal policy has increased the size of governmental debt, leading to the accumulation and aggravation of fiscal and public risks.

Given the circumstances of existing pressures from an overheated economy and rebounding investment, the most ideal aim for fiscal policy transition should be a move to balanced budgets or even a slight surplus, in order to ease the negative influence of fiscal policy on monetary policy effectiveness. However, in reality, this is complicated by a few factors. First, the coexistence of short-term overheating in certain sectors and the long-term unpopularity of some industries determines that, to some extent, fiscal policy transition should be carried out incrementally. Second, the transitional mode of fiscal policy also depends on whether the subjective judgment of the current macro economy coincides with real economic development. Third, there exists the problem of follow-up funds for T-bond projects, the long-term construction of which must be backed by follow-up investment. This, to a large extent, would restrict the pattern and degree of fiscal policy transition. Finally, with a potential breakthrough in the acquired interest structure, the sudden abandonment of proactive fiscal policy might result in social conflict; therefore, the reform of fiscal policy necessitates a transitional phase.

Specific details and fine-tuning may be carried out in terms of the mode and degree of fiscal policy transition. The size of long-term construction T-bonds is bound to decline in 2005, and construction investment is very likely to rise in the central government's budget. The decrease in issuance of long-term construction T-bonds cannot effectively reflect the degree of fiscal policy transition; a more important indicator will be the size of the annual fiscal deficit. Furthermore, the "active" part of the fiscal policy will be retained by the increase in construction investment in the budget, further reduction of agricultural taxes, and a change in value-added tax. If fiscal policy requires a higher degree of contracting adjustment, the problem would arise concerning the follow-up funds for T-bond projects. Consequently, there should be discussion and research on how to respond to various situations.

We hold that there should be a holistic view of fiscal policy transition, taking into consideration furthering economic reform and effectively reducing fiscal risks. The major measure is to explore sources for follow-up funds in T-bond projects. After a survey and research on the attributes of T-bond construction projects (including completed ones), social funds, to fill the gaps in follow-up funds, should be introduced into those marketable projects by means of BOT, cooperative operation, and contracted operation, in order to ease the fiscal burden on the government, which may then withdraw some of the fiscal funds for the overall economic reform and development.