The Chinese Ministry of Finance is addressing local debt issues prior to addressing broader economic difficulties.

• Despite some investors expecting fiscal stimulus, China's Ministry of Finance emphasized its focus on addressing local government debt during its weekend press briefing.
• The Minister of Finance, Lan Fo'an, presented four solutions, commencing with enhancing assistance for local governments in managing financial risks.
• Robin Xing, chief China economist at Morgan Stanley, and his team stated in a report Sunday that the press conference aligns with their belief that resolving local government financing difficulties is a top priority.

The Ministry of Finance in China emphasized its focus on resolving local government debt issues rather than providing the stimulus that markets were anticipating, during a press briefing over the weekend.

Lan Fo'an, the Minister of Finance, announced four measures on Saturday to address debt risks in local governments. He later revealed that the country was considering increasing debt and the deficit.

Robin Xing, chief China economist at Morgan Stanley, and his team stated in a report Sunday that the press conference aligns with their belief that resolving local government financing difficulties is a top priority. Additionally, they anticipate that the central government will take on a greater role in debt restructuring and stabilizing the housing market.

Despite the real estate market slump and financial struggles of local governments, the Morgan Stanley analysts predict that upsizing consumption support and social welfare spending will likely remain gradual. Meanwhile, calls for more fiscal stimulus have increased due to lackluster consumption and slow growth overall.

The four policies announced by the Ministry of Finance are geared towards addressing structural problems, according to a report by Chinese economic think tank CF40 on Saturday.

The report stated that expectations of greater government intervention do not specifically target macroeconomic issues such as insufficient aggregate demand or declining price levels through Keynesian-style fiscal expansion.

According to CF40, China can achieve its full-year growth target of approximately 5% without requiring additional fiscal funding, provided that the previously announced spending is completed by the end of the year.

Local governments drag on domestic demand

On Saturday, Finance Minister Lan announced that the central government would permit local governments to utilize 400 billion yuan ($56.54 billion) in bonds to fund payroll and essential services.

Lan stated that the local governments' hidden debt levels at the end of 2023 were half what they were in 2018. He added that a large plan to address this issue would be announced in the near future, without specifying the exact date.

In 2021, Rhodium Group stated that historically, local governments were responsible for more than 85% of expenditure but only received about 60% of tax revenue.

The International Monetary Fund stated in an Aug. 30 report that China's constrained local government finances have contributed to the downward pressure on prices.

In September 2021, the core consumer price index, which excludes volatile food and energy prices, increased by 0.1% compared to the previous year. This was the slowest rise since February 2021, as per the Wind Information database.

Resolving local government debt problems is a "vital step" in stopping the decline of prices, almost as crucial as stimulus aimed at increasing demand, according to Morgan Stanley.

Waiting for another meeting

Following a series of policy declarations in recent weeks, investors are anticipating China's parliament meeting, scheduled for the end of the month. As per China's legal procedures, the parliament must approve any changes to the national budget. During the previous meeting, which took place on October 24th, there was a rare increase in the fiscal deficit to 3.8%, from 3%, according to state media.

There is disagreement among analysts regarding the precise level of fiscal assistance required.

"Vikas Pershad, fund manager at M&G Investments, stated on CNBC's "Squawk Box Asia" on Monday that the difference between 2 trillion and 10 trillion yuan for them is not significant. He added that their investment in China is a long-term bet and the Chinese equities are undervalued."

Regardless of the stimulus size, he emphasized that the policy direction is "on the right path."

Since January, Pershad has discussed purchasing opportunities in Chinese stocks, but on Monday, he stated that the recent surge of activity from the region has not prompted him to become more active in the sector.

Beijing did not provide financial assistance to consumers like Hong Kong and the U.S. did, and China's policymakers have generally remained conservative.

According to Julian Evans-Pritchard, head of China economics at Capital Economics, at least 2.5 trillion yuan of additional funding is required to maintain a growth rate of approximately 5% this year and the following year.

"He stated on CNBC's "Squawk Box Asia" on Monday that if the economy does not improve, it is likely to slow down even more due to the structural challenges it faces."

Evans-Pritchard argued that fiscal policy is the most crucial tool for dealing with the current economic downturn, as real estate and credit, which have been used in the past, are not as effective now.

"Obviously, there is a lot of discussion about recapitalizing banks and addressing local government debt problems, but if a significant portion of the additional borrowing is directed towards these areas, it may not significantly stimulate current demand."

— CNBC's Sonia Heng contributed to this report.