China - Government Spending Growth Set To Slow

BMI View: We expect both China's government revenue and spending growth to moderate in the second half of 2017. That said, we are upgrading revenue growth for 2017 from 4.0% to 6.0%, which will lower the fiscal deficit to 3.5% of GDP from our 4.0% forecast previously. The easing of fiscal spending will act as a drag on short-term economic growth, and we forecast real GDP growth to slow to 6.6% for 2017, from 6.9% y-o-y in H117.

We expect both government expenditure and revenue growth to slow in H217. We forecast spending growth to slow to 9.5% for 2017 from an expansion of 15.8% y-o-y in H117, as the government will be more willing to comply with its budget targets amid better-than-expected economic performance. The deceleration in spending growth will consequently weigh on economic growth over the coming months. While we are upgrading our 2017 revenue growth forecast to 6.6% from 4.0% previously - which will bring the fiscal deficit to 3.5% of GDP down from our previous forecast of 4.0% previously - it will still mark a slowdown from a growth rate of 9.8% y-o-y in H117.

Expenditure Growth Set To Decline

In our view, spending growth will likely slow in H217 as the government faces pressure to comply with its 2017 budget outlined in March. The MOF reported that fiscal spending rose by 15.8% y-o-y in H117, which was significantly higher than its 2017 target of 6.5%, which puts pressure on Beijing to curb spending in an effort to meet its 2017 budget deficit target of 3.0% of GDP. According to our estimates, the budget deficit will come in at 5.1% of GDP if Beijing maintains the H117 level of spending (15.8% y-o-y), nominal GDP (11.0% y-o-y), and revenue growth (9.8% y-o-y) for the rest of the year. Additionally, strong economic growth in H117 reduces pressure on Beijing to support the economy with an aggressive expansionary fiscal policy, which again suggests that Beijing will likely curb spending in H217. Indeed, real GDP growth came in at 6.9% y-o-y in H117, which was significantly higher than the government target of around 6.5% for 2017 (see 'Li's NPC Speech Seeks Balance Between Growth And Reforms', March 6).

Revenue Growth To Slow In H217

Given the strong economic performance in H117, nominal GDP growth will likely outperform the benchmark growth rate used in the FY2017 budget report (see 'FY2017 Fiscal Report: Beijing Will Overspend', March 9), which will bode well for revenue collection. In addition, import tax revenue will remain supported as Beijing's commitment to opening up domestic markets to foreign companies will provide some tailwinds to total imports.

hat said, government revenue growth will still come in much lower in H217 when compared with the growth rate registered in H117. Producer price inflation will likely moderate in H217 due to credit tightening, easing fiscal spending and unfavourable base effects, which will consequently weigh on revenue growth. In addition, various supply-side reforms proposed by the government will take effect in H217, which will pose additional downside pressure on revenue growth. Indeed, on July 1, Beijing lowered business tax rates for agricultural products, books, fertilisers, pesticides, and natural gas to 11.0% from 13.0% previously; the purchase of health insurance will also become partially deductible in H217 (see 'Tax Cuts To Improve Market Efficiency', April 21).

Negative For Short-Term Economic Growth

The potential slowing of fiscal spending will weigh on infrastructure investment, which was an important driver of growth in H117, and will consequently act as a drag on short-term economic activity. Infrastructure investment growth slowed slightly to 20.0% y-o-y in Q217 from 23.5% y-o-y in Q117, as government spending growth dropped to 12.4% y-o-y from 21.0% y-o-y during the same period. Furthermore, a decline in infrastructure investment growth could act as a drag on prices of industrial metals, which will weigh on the profitability of related companies, posing additional downside pressure on the economy. As such, we forecast China's real GDP growth to decelerate to 6.6% for 2017, from 6.9% y-o-y in H117 (see 'Economy To Lose Steam Despite Strong H117 Figure', July 17).

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