China tries to dam the deluge of negative news as economic floodwaters rise

(Originally published Aug. 7 in “What in the World“) The first rule of deflation is you do not talk about deflation.

So say China’s economists, who have told the Financial Times they’re being warned by regulators and their employers to avoid saying anything negative about the economy, whether falling prices, skittish consumers or capital flight. And the China Securities and Regulatory Commission has reportedly scolded analysts for badmouthing the economy, too.

Simply avoiding negative sentiment is no replacement for stimulus when it comes to reviving economic growth. At most, it can reduce the risk of financial contagion or bank runs, not to mention slow the spread of deflationary expectations—when consumers stop spending because they know that the price of things will only go down tomorrow.

But the bad news just keeps coming. As authorities divert floodwaters into surrounding cities to save Beijing from being inundated, severe storms are damaging China’s crops and helping push food prices higher.

Two successive typhoons this month have had a severe impact on grain production in China’s northeast as the country copes with Russia’s pullout last month from the Black Sea Grain Initiative, which allows Ukraine to export wheat. China is the biggest importer of Ukrainian wheat and Russia has turned to bombarding Ukraine’s key grain export facilities. Making matters worse, India recently banned exports of rice in response to soaring prices there.

China’s Ministry of Agriculture and Rural Affairs said Wednesday that 432 million yuan ($60 million) in financial aid would be allocated to farmers.

Economists also say Beijing may finally be ready to bail out cash-strapped local governments. For many years, authorities have been trying to get provincial and city governments to just keep selling new bonds to restructure and refinance their estimated 92 trillion yuan ($12.9 trillion) in debt in hopes that growth allows them to pay it down over time, with some lenders taking manageable haircuts in the process.

Instead, the debt pile has just gotten larger and more unsustainable. Now, the growing cost of servicing it is forcing local governments to cut services to avoid going broke. Much of the debt is owed through local government financing vehicles (LGFVs). The International Monetary Fund estimates LGFVs may have now racked up as much as 66 trillion yuan ($9.24 trillion), more than double what they had in 2017.

Letting the local governments go broke could rattle the entire financial system as it’s China’s banks that hold most of the bonds local governments have been selling. By at least one estimate, LGFVs’ bonds may now account for up to 40% of assets at China’s banks.

Beijing has already funneled cash to provinces to help pay for local services. But it may start considering allowing the sale of local governments bonds backed in part by the national government. That would allow local governments to reduce their debt-servicing costs by lowering interest rates they pay—now as high as 10% a year—closer to what Beijing pays, 3% and lower. But it would increase China’s sovereign debt, something Beijing has strenuously resisted.