The long-standing issue of local debt, which has not been far from the public’s mind, has recently caused a great uproar. Recently, an official think tank in Southwest China’s Guizhou province issued a statement after researching the local debt situation in many cities and counties in the province, stating that the province was “constrained by limited financial resources, and the progress of debt reduction is extremely difficult. Relying solely on its own capabilities is no longer effective.”
To what extent this article represents the local government’s position is unknown, but such a statement is unprecedented. The public has been discussing this issue. At the beginning of this year, when the Ministry of Finance replied to several proposals from members of the National Committee of the Chinese People’s Political Consultative Conference last year, it stated that it should stably reduce the outstanding implicit debt; adhere to the principle that there should be no bailouts from the central government.” Obviously, this principle still applies today. On the issue of local debt, financial discipline should not be relaxed, nor can it be.
Local debt expanded sharply after the global financial crisis in 2008. Since the implementation of the State Council’s guidelines on Strengthening the Management of Local Government Debt (known as "Document No. 43") in 2014 and the new budget law in 2015, the trend of out-of-control local debt has been curbed, but the root cause has not been eliminated.
Since 2017, the balance of local government debt has been rapidly increasing at an average annual rate of 16.3%, far higher than the nominal economic growth rate of 7.8% during the same period. At the end of 2022, the local government debt-to-GDP ratio was 29.1%. At the end of 2021, the local government debt-to-revenue ratio was 105.8%, exceeding 100% for the first time. Although the overall government debt risk is controllable, the rapid growth of debt is still a major problem for the Chinese economy.
As far as China’s local debt problem is concerned, the most worrying issue is the size of the outstanding implicit debt, for which there has never been reliable data. The effectiveness of debt use is also worrying. For instance, with an annual fiscal revenue of less than 1 billion yuan, a Guizhou county called Dusha, once had as much as 40 billion yuan in local debt, and even spent nearly 200 million yuan to build the unfinished structure it called the “World’s No. 1 Water Bureau Building.” Such shocking “face projects” are not uncommon.
The issue of expanding the use of local government special bonds has also raised serious concerns. Local government’s special bonds are supposed to be issued for public welfare projects that generate a specific return, and are then supposed to be repaid with corresponding government funds or special revenues over a set period of time. Since 2019, the scope of their use has been expanding, especially since special bonds were allowed to be used to supply capital for major projects, and since their duration to maturity was significantly extended. In 2022, the scale of local government’s issuance of special bonds exceeded 5 trillion yuan for the first time, an all-time high that was more than double the issuance size in 2019. As of the end of 2022, the balance of local special bonds reached 20.67 trillion yuan, accounting for more than 20% of the bond market. This rapid growth in this kind of debt has led to a sharp increase in interest payments. Special bonds are no longer living up to their name and have become de facto general debt, making it more difficult to accurately assess government debt risks.
All these issues represent a challenge to fiscal discipline and test the country’s ability to govern.
The reason for the continuous growth of local government debt is quite clear. It is related to the specific stage of China’s economic and social development. The economic downturn has increased the pressure on government budgets, and local finances have come under increasing strain. However, the fundamental problem lies in the lagging of institutional and mechanism reforms, and the failure to straighten out the fiscal relations between levels of government.
For one thing, relying on land revenue is unsustainable, and the sources of the local tax revenue are limited. In addition, transfer payments from the central government remain insufficient for the large amount of local debt. For another, the adjustments of fiscal powers and expenditure responsibilities lags behind, and local governments, especially those below the provincial level, still face the dilemma in which they have a growing list of tasks assigned by higher levels of government, but don’t have much say over fiscal policy. Meanwhile, the performance evaluation system and promotion mechanism for local officials still encourages them to prioritize investment over fiscal discipline.
It should also be noted that in the past three years, under the combined impact of the Covid-19 pandemic, a profound changes in the real estate industry, and tax and fee reductions at all levels of government, local government finances have remained under pressure, with significant regional disparities. Local governments have undertaken a large amount of anti-pandemic expenditures, resulting in increased gaps between local revenues and expenditures, and many places are financially strapped. It can be said that the consequences of delays in both public health and fiscal system reforms are reflected in the risks of local government debt. With limited room for maneuver, the challenges to fiscal discipline have become unavoidable.
The path to resolving local government debt has long been clear, and the key is to act. We should deepen fiscal and tax system reforms, and establish a standardized and reasonable early warning mechanism for central and local government debt. This year’s government work report proposes that the country should “deepen the reform of the budget management system, increase the transparency of the budget, promote the reform of the division of fiscal powers and expenditure responsibilities between the central and local governments, and improve the local government debt management system" and "prevent and resolve local government debt risks, optimize the structure of debt maturities, reduce interest burden, and control incremental and resolve existing debts." We hope these measures will be effective.
In addition, accountability and supervision over local government debt-raising should be strengthened. After the implementation of the "No. 43 Document," the fiscal authority once announced dozens of cases of local government officials who violated debt regulations. However, in recent years, local debt risks have re-emerged, but few such cases have been made public, which is quite unusual. At the very least, the government should investigate cases that have violated fiscal discipline in the eight years since the adoption of the document in 2014.
In short, on the issue of local government debt, the principle of no central bailout must be upheld. If one place is bailed out, others will inevitably follow, which will further stimulate the increase in local debt and lead to unrest in the country. Over the next two years, local government debt repayments will peak, and risks will become increasingly apparent. At such a critical time, it is necessary to adhere to fiscal discipline.
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