China’s government is turning increasingly to tax cuts as the first line of defense against a slowing economy, as credit data released Tuesday showed some vindication of its gradual stimulus strategy.

Further evidence of the dominance of fiscal measures emerged, as senior policy officials pledged that tax reductions on a “larger scale” are in the pipeline, amid worsening output and trade data. JPMorgan Chase & Co. economists estimate the total impact will be around 2 trillion yuan ($300 billion), or 1.2 percent of gross domestic product.

That’s a departure from the infrastructure binges coupled with massive monetary stimulus that were deployed in the aftermath of global financial crisis. Beijing is trying to put a floor under the economic slowdown without another debt blowout, with some success: Credit growth exceeded expectations in December, and the central bank has managed to curb riskier shadow banking throughout the year.

Aggregate financing
(billion yuan)
1,524 1,590 1300
New yuan loans
(billion yuan)
1,250 1,080 825
M2 money supply
(% year-on-year)
8.0 8.1 8.1

“At the moment the room for monetary policies is limited, and fiscal policies such as tax cuts are the crucial tool,” said Cui Li, head of macro research at CCB International Holdings Ltd. in Hong Kong. The high leverage and property prices have limited the chances of massive monetary stimulus, she said.

“But as a pro-growth measure, tax cuts will take effects at a slower pace compared to infrastructure binges,” she said.

Last May the government cut value added taxes for manufacturing, transportation, construction, telecommunications and farm produce industries, followed by a cut in personal income taxes and the introduction of more deductions. Earlier this month, the State Council announced a $29-billion annual tax cut plan for small companies.

The change of approach is being driven largely by China’s debt load, which makes funding a splurge on bridges and railways dangerous for financial stability. Against the backdrop of slowing global growth and the trade war with the U.S. though, it’s not clear whether the new approach will be enough to stabilize the economy.

The government “has grasped the problem” after years of over-investment led to low efficiency and surging debts,” JP Morgan economists led by Zhu Haibin wrote in a report. The impact on growth could be modest though, they wrote as more vigorous tax collection can dampen the benefit and the transmission of tax cuts to the economy is uncertain.

In all, the reductions may boost gross domestic product growth by 0.46 percentage point, the economists said. The world’s second-largest economy is being hit by a confluence of slowing global growth and by uncertainty linked to the trade war — factors that are expected to linger in the near term, at least.

Zhu Hexin, deputy governor of the People’s Bank of China, Xu Hongcai, assistant minister of the Ministry of Finance, and Lian Weiliang, vice chairman of the National Development and Reform Commission, briefed reporters on the policy changes Tuesday in Beijing, and also pledged to support consumption of cars and household goods. Chinese vehicle sales fell for the first time in 28 years, data released Monday showed.

Xu said that the government would allow local governments to issue more special bonds in 2019 compared to 2018 to ensure continuous construction of ongoing infrastructure projects, but that this doesn’t mean weaker oversight.

“Tax reduction is almost the only way to boost personal consumption and private businesses” which are the main worries in the current slowdown, said Wang Jian, a Shanghai-based economist at Shenwan Hongyuan Group Co. “The government is very reluctant to go back to the big stimulus, and relaxing property policy is unlikely.”

The nation’s augmented fiscal deficit — taking into account quasi-fiscal efforts such as special bonds and land sales — will jump to 11.3 percent of the economic output this year from 10.7 percent last year, JPMorgan forecast. Bloomberg reported that China will widen its fiscal shortfall earlier this month.

Tariff Cuts

China also announced three rounds of import tariff cuts last year, in an effort to cut costs for consumers, and implement President Xi Jinping’s promises to open up further.

Worse-than-expected trade data published Monday underlines the risk to the economy in the first quarter, as its still unclear how much new credit is filtering through to where it’s needed. The strategy has also yet to turn around sentiment in the real economy, which could register the slowest growth in nearly three decades in data scheduled for release next week.

The government is likely to set a growth target of between 6 and 6.5 percent for this year, Reuters reported last week.

Carie Li, an economist at OCBC Wing Hang Bank Ltd in Hong Kong, reads the credit data as still displaying the negative effects of the multi-year campaign to wring out shadow banking.

“The new wave of stimulus measures was still unable to weather the impact of the previous crackdown on financial leverage,” she said. “As such, it is likely for the central bank to step up efforts in supporting the funding needs of privately-owned enterprises.”