Prudent fiscal and monetary policies are still needed

The country is now seeing an economic divergence in terms of regions, industries and businesses that, in addition to the distribution of debt by region, will create accumulative effects. As a result, the accumulation of local government debt－which is based on urban expansion and project investment and sees participation by local government financing vehicles, local financial institutions and local State-owned enterprises－will reach a new level.

To solve the local government debt problem, we must push ahead with reforms of local State-owned enterprises, local financial systems and local fiscal and tax systems over the next few years. The strategic deployment may truly dismantle various time bombs China faces.

These gray rhinos will reverse continuous expansion of external demand and make it unlikely for local governments to become engines driving economic recovery amid financial risk shocks. Therefore, China's economic recovery in the second half and the beginning of next year will not be as smooth as optimists anticipate.

What deserves equal attention is that China will replace its old development strategy with a new one and fully implement its new dual-circulation development paradigm this year, which takes the domestic market as the mainstay while letting domestic and foreign markets boost each other.

The country must achieve economic recovery and growth amid the transition of growth drivers and strategic paradigms. This requires adjustment of the benefit mechanism, especially the establishment of incentive and restraint mechanisms that can adapt to the transition and new strategic deployment.

Current fiscal expenditure shows the lack of enthusiasm among local governments for investment is due to a lack of quality projects. In the second half of this year, the mechanisms promoting self-reliance and self-improvement in science and technology, "new infrastructure" and new technology deployment－as well as the establishment of complete domestic supply chains－are still imperfect, so that domestic demand expansion brought by China's new strategy for development may not realize expected goals. Under such circumstances, if the country overtightens its monetary and fiscal policies, it may face several challenges.

First, it is hard for China to deal with external shocks that are beyond expectations.

Second, it is difficult to create a relatively loose environment for deep-level reforms.

Third, it is challenging to provide financial support for the full implementation of the new dual-circulation development paradigm and to create sufficient conditions for the upgrade of domestic circulation.

Fourth, the country's positive economic data at the current stage do not yet warrant policy tightening.

Therefore, in my view, China should accelerate the pace of fiscal spending in the third and fourth quarters, especially in the third quarter. The country should also speed up total social financing growth and credit issuance rather than simply exit from expansionary monetary policies due to uneven and unsolid economic recovery and the potential for gray rhino shocks.

The writer is vice-president of the Renmin University of China in Beijing. The article is based on his recent speech to the China Macroeconomy Forum.

The views don't necessarily reflect those of China Daily.