Prudent fiscal and monetary policies are still needed

Although it is necessary for China to eventually exit from expansionary monetary and fiscal policies, it is inadvisable for the country to fully cease such unconventional policies at present, as the world's second-largest economy still faces potential gray rhino shocks.

The country ceased issuing special antivirus government bonds for COVID-19 control and stopped providing interest subsidies for loans granted to key enterprises guaranteeing supplies for pandemic prevention and control.

Unconventional policy measures will bring huge shocks to the order of the market economy if they last too long, as there will always be aftereffects from large-scale stimulus packages. Therefore, China must bring an end to unconventional policies. However, we should think carefully about whether or not the country should completely exit from expansionary monetary and fiscal policies.

The key to answering this question is twofold: First, whether China's economic growth has normalized, with the output gap－an economic measure of the difference between the actual output of an economy and its potential output－being around zero. Second, whether the momentum of economic growth has normalized and will maintain stability over the short to medium term.

If we take a look at the current level of employment and the level of the core consumer price index, we will find that China's level of output has not fully returned to trending tracks. We are not only facing problems of economic instability and disequilibrium but also gray rhino shocks which will lead to systemic changes.

One of the gray rhino shocks is that the external environment of China will likely face big changes at the end of this year and the beginning of next year for several reasons.

First, thanks to improved macroeconomic data, the US Federal Reserve may adjust expansionary monetary and fiscal policies, which will lead to huge changes in the world's liquidity and financial environment.

Second, despite uncertainties during the COVID-19 pandemic, the speed of global economic recovery is faster than expected, and the recovery of global supply and industry chains will also be faster than expected. This will quickly mitigate the problem of a mismatch between supply and demand around the world.

Third, the containment strategy that the United States adopted by rebuilding an alliance of democracies and reshaping supply chains to challenge China is advancing more rapidly than we imagined and may further squeeze the Chinese economy, going forward.

Finally, all countries will begin redesigning supply chains, industry chains and innovation chains after the COVID-19 pandemic, thus leading to major changes in the global division of labor system and the pattern of world trade.

We should watch out for the above situation, although we may think that the Chinese economy has returned to vibrancy because of the current boom of foreign investment and foreign trade. However, if China had not made strategic arrangements for domestic demand expansion beforehand, once the external economic factors reverse, the country may have a more serious excess capacity problem than it did in 2019.

The other gray rhino is the worsening of regional financial risks, which we have followed closely for many years.

As early as 2014, China paid close attention to the problem of a rapid increase in local government debt and the growth of hidden debt, but we made no substantial progress in solving the problem.