MNI INTERVIEW 2: China Fiscal Stimulus Key To Deflation Fight

China must undertake large-scale fiscal expansion to break free from deflation and tackle the debt problems stemming from excessive past investment, a prominent economist and advisor told MNI, urging policymakers to shift their focus from GDP growth to asset prices to boost the yuan and revive consumption.

Policymaker’s immediate priority is to lift inflation toward 3% via primarily fiscal tools, while monetary policy could help lower debt issuance costs and ensure liquidity, said Xiao Geng, associate dean of School of Public Policy at the Chinese University of Hong Kong, Shenzhen. 

Xiao, also chairman of the Hong Kong Institution for International Finance, noted that until September 2024, China’s macroeconomic and financial policies remained overly cautious, marked by a weak yuan, limited stimulus, and subdued capital market returns. He called on fiscal authorities to abandon the traditional balanced budget “spending-based-on revenue” mindset, arguing China faced structural challenges amid deflation rather than a routine economic cycle.

Fiscal policy must tackle debt issues, with the central government taking responsibility for bad local government debt by issuing perpetual, or ultra-long-term bonds, Xiao said, noting much of this debt originated from previous over-investment, which was necessary for economic expansion.

Local governments, burdened by debt, have cut spending, undermining economic support efforts and the central government – with a healthy balance sheet – must step in, Xiao argued. Local governments currently rely on refinancing swaps that lower interest costs and extend maturities but fail to improve their fiscal positions, limiting their ability to stimulate investment and consumption. (See MNI: PBOC Seen Resuming Bond Purchases As Gov't Issuance Rises)

Fiscal policy must also expand the deficit to increase government spending to repay enterprises and invest in underfunded sectors tied to people’s livelihoods, including health, sports, and entertainment infrastructure, Xiao added.

UNDERVALUED YUAN

Xiao highlighted a sharp policy divergence between China and the U.S. as a major factor behind the yuan’s severe undervaluation and weakened yuan-denominated assets. 

While the U.S. has pursued strong economic and financial policies, characterised by a strong dollar, robust stimulus, and high capital market returns, China’s more cautious stance has exacerbated capital outflows and investor pessimism and lead to tighter capital controls, he continued. From both purchasing power and international payment standpoints, the yuan should have appreciated against the dollar, possibly nearing the 6.0 mark, he added.

To reverse this trend, China must drive consumption by boosting corporate profits, household incomes, and overall social wealth – encompassing the value of real estate, equities, and digital assets, he said.

Xiao also noted Hong Kong's plans to develop an offshore yuan stablecoin will help drive the currency's internationalisation. (See MNI INTERVIEW: HK Eyes CNH Stablecoin For Asset Expansion)

ASSET PRICES

Focusing on asset prices and overall wealth, rather than GDP growth alone, should guide policy decisions, Xiao suggested, pointing to the U.S. stock market boom, underpinned by fiscal and monetary expansion, and Hong Kong’s recent bull market, which heavily depended on policy support including IPO activity and mainland fund inflows.

However, he warned that if deflation persists and corporate profits fail to improve, sustaining the bull market may prove challenging.

Xiao proposed increasing yuan usage in trade settlement, citing Russia’s requirement that oil and gas buyers pay in rubles as a model that supported its currency despite sanctions. Given China’s global manufacturing leadership, requiring yuan payments for Chinese goods could similarly bolster demand for the currency, he said.