MNI: China Govt Needs More Debt To Sustain Growth - Advisor

China faces an extended period of sub-potential growth unless it bails out local governments and subsidises home purchases, a prominent economist told MNI, though he noted that this would require a significant change of heart by policymakers.

While top policymakers still hope for growth this year of 5% or higher,  nominal GDP is currently expanding by only about 4.2% and inflation is well below what could be considered the normal range of 2-3%, said Li Daokui, director of the Academic Center for Chinese Economic Practice and Thinking at Tsinghua University. This compares with potential growth which he calculates at 5.2%. 

Li, who served on the People’s Bank of China’s monetary policy committee from 2010-2012 and has remained an important policy advisor, pointed to the quarter-by-quarter decline in growth during 2025 and said it was still unclear that the economy has bottomed out.

Local governments, formerly the main source of domestic spending, are now the biggest drag on growth, said Li, who called for the central government to swap out their existing debt by issuing as much as CNY30 trillion in ultra-long-term special treasury bonds. This would raise the central government's debt-to-GDP ratio from the current 28% to around 78%, still lower than 120% in the U.S and 260% in Japan, he said. (See MNI: China NPC To Unveil More Off-Deficit Debt, Rate Cut Eyed)

China’s other stalled growth engine is real estate, with property prices crucial for household wealth as well as driving revenues for industry and local governments. Li said the central government could temporarily subsidise new mortgages, lowering rates by 1-percentage point, and fund this with more ultra-long special treasuries. Assuming new individual housing loans of CNY7 trillion, first-year subsidy expenditure would be about CNY70 billion, he said.

In an extreme scenario in which these subsidies continue for several years, supporting new loans of CNY40 trillion, total subsidy expenditure would be CNY400 billion, he said, adding that this would still be relatively low cost and efficient in boosting demand compared with existing government programmes such as that for trading in consumer goods.

Subsidising mortgages, coupled with continued relaxation of home purchase restrictions, could stabilise real estate markets in first- and second-tier cities by the end of 2026, Li estimated.

LOCAL DEBT

Declining revenues and rising debt costs have prompted local governments to delay payments to contractors, including about CNY10 trillion in overdue payments to companies carrying out investment projects, as well as to raise taxes, the economist said. The current scale of local debt swaps is far from sufficient to break this vicious cycle of declining demand, according to Li.

Local fiscal constraints also undermine the effectiveness of monetary easing. Because local governments, households and companies are all severely constricted in their willingness and ability to invest and borrow, financial markets are left with excess liquidity, Li said.

Assuming an interest rate on local governments' existing hidden debt of 5%, swapping it out for treasury bonds at 1.9% could reduce annual interest expenditure by about CNY930 billion, he calculates. (See MNI: Lower China GDP Growth Eyed Amid Economic Headwinds)

SHIFT MINDSET

However, while Li believes that significantly increasing treasury bond issuance would be the most effective and lowest-cost measure to stabilise the economy, he acknowledges that this would requires policymakers to alter entrenched mindsets, adding that "the hardest thing in the world is to change mindset.”

Policymakers have long worried that a bailout would encourage moral hazard, leading local governments to borrow more, and that adding to the national debt would undermine the strength of central government, he noted.

But, Li argues, with the biggest wave of massive Chinese infrastructure construction now concluded, local governments have fewer incentives for large-scale borrowing. At the same time, most of the central government’s debt is linked to profitable assets, he said, noting that state-owned companies’ assets account for more than 50% of GDP.

China’s enormous sovereign net wealth provides it with quasi-fiscal tools for supporting the economy, boosting equity markets and mitigating local debt risk which are unavailable to western governments, Li said.

In addition, the current stock of Chinese treasury bonds is insufficient to meet market demand for safe assets, Li noted, adding that increased issuance could easily be absorbed without excessive monetary expansion given the country’s high savings rate.

If nominal GDP grows at an average annual rate of 6% over the next decade, the debt ratio would gradually decline, given that the interest rate on treasury bonds would be much lower than 6%, he said.