Will Higher Deficit-to-GDP Ratio Increase Fiscal Risks?

This year, China will adopt a more proactive fiscal policy, coordinate various types of fiscal funds and ensure its fiscal policy will be more effective, according to the government work report released on March 5.

The deficit-to-GDP ratio will be raised by 1 percentage point to 4 percent, pushing the total deficit to 5.66 trillion yuan ($789 billion), up by 1.6 trillion yuan ($223 billion) from last year. The general public budget expenditure will increase 1.2 trillion yuan ($167 billion) to 29.7 trillion yuan ($4.14 trillion). A more proactive fiscal policy will provide a stronger impetus for the Chinese economy to achieve a reasonable growth in quantity and effective improvement in quality.

China’s deficit-to-GDP ratio generally remained below 3 percent in most previous years, except in 2020, when it exceeded 3 percent to address the challenges posed by COVID-19. This year the ratio will reach around 4 percent for the first time since China adopted its reform and opening-up policy in 1978.

According to International Monetary Fund (IMF) standards, 3 percent is often regarded as a warning line for a country’s deficit-to-GDP ratio. A ratio exceeding 3 percent is considered likely to affect the country’s credit rating and the confidence of international investors. Therefore China’s plan to increase the deficit-to-GDP ratio to 4 percent has aroused some concerns within the international community, a major one of which is whether increasing the deficit-to-GDP ratio will pose risks to China’s fiscal security.

At the crux of this question is China’s fiscal balance and the stability of its economic growth. If fiscal revenue and GDP maintain stable growth, it will be safe for the country to raise the deficit-to-GDP ratio a little without facing a fiscal crisis. Conversely, if an increase in the deficit-to-GDP ratio cannot stimulate stable economic growth, risks would arise.

The fundamental reason for China to increase deficit is to promote economic growth by increasing fiscal spending. The expansion of fiscal expenditure is based on a low leverage ratio of government debt.

According to figures from the Research Center for National Balance Sheet, part of the Chinese Academy of Social Sciences’ National Institution for Finance and Development, the leverage ratio of China’s central departments stood at a low level of 25.6 percent at the end of 2024, indicating that the Central Government still has a large space for borrowing. Even after the deficit increases moderately, the Central Government’s debt ratio is still safe and controllable because China’s overall government debt has been at a low level. According to the Ministry of Finance, the balance of government debt in China accounted for 60.9 percent of the GDP at the end of 2024, with the debt risks generally safe and controllable. IMF figures showed that at the end of 2023, the average government debt ratio of G20 countries stood at 118.2 percent, while the ratio of G7 countries reached 123.4 percent. Many countries have their debt ratios exceed 100 percent, such as Japan (249.7 percent), Italy (134.6 percent), the United States (118.7 percent), France (109.9 percent) and Canada (107.5 percent). Obviously, China’s approach of moderately raising fiscal deficits is different from these countries, so it is unnecessary to fear that it will lead to a debt crisis.

To meet its development needs, a considerable part of China’s fiscal expenditure is used in production sectors, which can expand domestic demand and boost consumption. At present, there is still a lot of room for industrial upgrading and infrastructure improvement in China, and the proactive fiscal policy is in a stage of relatively high yield rate.

A rise of deficit-to-GDP ratio to around 4 percent may bring new impetus to China’s economic growth, but to do so requires guarding against potential side effects in advance. In the long run, persistently rising deficits will lead to higher debt levels, which may limit the space for fiscal policy readjustment. The high level of debt and sluggish economy in some Western countries offer a lesson.