(Yicai Global) Nov. 28 -- One of the biggest problems that the Chinese economy is currently facing is insufficient aggregate demand, with the actual growth rate lower than the potential one. More emphasis should be put on fiscal policy to ensure that this potential growth materializes.

Although both fiscal and monetary policies need to be further loosened, boosting the economy should mainly rely on fiscal policy as the effect of monetary policy easing is limited. In addition to increasing the amounts available, the efficiency of fiscal policy implementation also needs to be improved.

Looking ahead to next year, we believe that the central fiscal deficit should top 3 percent of gross domestic product. And local governments should issue more than CNY5 trillion (USD695 billion) in special bonds, because special bonds have become the most important source of funds for local governments to promote infrastructure construction.

The scale of national debts should also be significantly increased, and special treasury bonds may be issued again. Compared with local government bonds, treasury bonds are cheaper to finance and more sustainable.

In the second half, local governments were greatly assisted by policy-based financial instruments led by the China Development Bank and the Agricultural Development Bank of China, which allowed the funds to be used as capital for project investments. More such financial tools should be implemented next year.

We recommend improving the financing structure for infrastructure investment in order to enhance the effectiveness of fiscal policy. In the past, infrastructure investment was financed by local governments and interest rates were usually above 10 percent, which was unsustainable. In the future, treasury bonds should finance large-scale infrastructure projects, thereby reducing costs.

There are also very strict regulations on local government debt applications and the use of funds, which prevent local governments from making full use of debt funds. We believe that local authorities should have greater autonomy.

Finally, it is necessary to strengthen the coordination of fiscal and monetary policies, keep interest rates low and maintain sufficient liquidity, so as to help fiscal policy raise funds at a low cost.

In fact, since the second quarter, China has implemented relatively loose monetary policy, including several cuts in the reserve requirement ratio and benchmark interest rate. However, current financial indicators show that the Chinese market is not short of liquidity and credit supply, but rather is lacking in credit demand, because many businesses are unwilling to hike investment and individuals are reluctant to borrow money to buy houses.

Although an easy monetary policy cannot help on all fronts, it is impossible to do without loose monetary policy. In our view, the recent RRR cut is not as necessary as a rate cut, as the latter can reduce the cost of borrowing for businesses and individuals and help boost their credit demand.

We do not believe that the Chinese yuan has room for significant depreciation against the US dollar and we expect it to fluctuate between 6.9 to 7.4 in the short term. When the US dollar index peaks in the first half next year, the yuan is likely to rebound significantly in the second half, when there will be more room for the People’s Bank of China to ease monetary policy.

(The author is deputy director of the Institute of Finance, Chinese Academy of Social Sciences, and deputy director of the National Institution for Finance & Development)

Editors: Dou Shicong, Kim Taylor