The National People’s Congress (NPC) will be held from 5-12 March. The most important decision of the NPC session will be the central government budget for 2012. This note discusses what we expect from the budget.

1. On a cash basis, we expect the fiscal deficit to rise modestly from last year’s level, i.e., fiscal policy will be modestly expansionary.
We believe that the official budget deficit for 2012 (based on the current accounting method) is unlikely to exceed that of last year (RMB900bn). Specifically we forecast that the official deficit/GDP ratio may fall to 1.6% in 2012 from 2.0% in 2011. However, if one uses a cash-basis accounting method, the fiscal deficit may increase by RMB100-200bn in 2012, due to the allocation of “unused” funds to a “government reserve fund” (treated as 2011 expenditure in official fiscal budget reports) for actual spending in 2012. This implies that the actual deficit/GDP ratio may rise by up to 0.3ppts of GDP in 2012, i.e., a modest fiscal expansion.

2. Spending priorities will likely include public housing, agriculture infrastructure, health, education, culture, local bonds and consumption.
We believe that both overall revenue and expenditure growth rates for 2012 will be in the range of 10-15%. However, spending growth for a few areas will exceed overall expenditure growth. These spending priorities will likely include (roughly in the order of the ppts exceeding the overall expenditure growth): public housing, agriculture infrastructure, quota for local bond issuance, health, education and culture.
Specifically, we think funding for public housing will be the most important policy focus of the budget. Agriculture infrastructure spending could also rise significantly (e.g., by about 30%). Additional allocation for health care will likely support a significant increase in benefits covered by the rural health care system. In addition, we expect energy-saving and environmentally-friendly products to be subsidized by the government budget this year.

3. Tax cuts will be limited; the bright spot is the extension of Shanghai VAT reform.
We think the scope of tax cuts will likely be a disappointment relative to market expectations. Other than the personal income tax cut which started from September last year (to be claimed by the government as mainly a reform for 2012), there will unlikely be sizeable new tax cuts funded by the central government. The bright spot in tax reform, in our view, is the very likely extension of Shanghai's VAT reform (the conversion of business tax to VAT on the transport sector, equivalent to a tax cut) to a few more provinces and cities in 2012.

As for market implications, we believe that the budget will be viewed as a mild positive if investors can understand the actual expansion of the government’s fiscal stance on a cash-basis accounting method. On sectors, we believe that fiscal policy in 2012 will benefit health care (via a spending increase), transport (due to the VAT reform), and energy-saving products (due to subsidies), as well as providing mild support for construction materials (via a spending hike on public housing and agriculture infrastructure).

• [Editor:editor]