IMF urges China to spend more as fiscal cliff looms

The International Monetary Fund has urged Beijing to increase fiscal spending, warning that local government finances face a "true fiscal cliff" amid a sharp decline in land-sale revenue. IMF Managing Director Kristalina Georgieva stated at the fund's meetings in Bangkok that China needs to spend more to counter deflationary pressures, while the U.S. must save and Europe must invest. Georgieva projected that China's economic growth would slow to 4.5% this year from 5% last year, with a further drop to 4% expected in 2027.

While general government debt stands at approximately 68.4% of GDP, the fund estimates that augmented government debt, which includes local government financing vehicles and off-balance sheet borrowing, reached around 126.6% of GDP last year. This level is comparable to those seen in developed markets such as the U.S. and Europe. The financial strain stems from the collapse in land-sale income, a primary funding source for local infrastructure like roads and rail lines, which has halved since the property slump began in 2021.

The CF40 think tank estimates that land-sale income fell from 8.7 trillion yuan in 2021 to 4.2 trillion yuan, or about $590 billion. Ting Lu, chief China economist at Nomura, noted that combined fiscal spending declined by 3.5% in the first eight months of the year, reversing a 3.6% growth rate seen last year. Lu described this shift as a real drag on the economy. Consequently, urban fixed-asset investment dropped by 3.8% last year and fell by 7.2% in the first three quarters of this year.

Beijing has set an official deficit target of about 4% of GDP, but the Institute of International Finance estimates the actual deficit could reach as much as 9%, a figure it deems insufficient. To address the debt overhang, Beijing has directed state-backed lenders to eliminate hidden liabilities and convert into market-driven commercial state-owned enterprises by mid-2027. S&P Global Ratings reports that hidden debt in these vehicles shrank to 6.5 trillion yuan ($973.3 billion) last year from 14.3 trillion yuan in 2023, though many entities still lack the cash flow to service interest payments.

Krishna Srinivasan, director of the IMF's Asia and Pacific department, advised Beijing to adopt a medium-term fiscal framework that allows for near-term expansion to reflate the economy while ensuring debt sustainability over time. The IMF also recommends moving away from point growth targets, which it argues encourage excessive local investment and resource misallocation. Logan Wright, partner at Rhodium Group, cautioned that no local government official wants to be the first to default, but noted that once Beijing bails out one entity, others may expect similar treatment, potentially conflicting with central government priorities.