Caixin
Dec 18, 2018 12:41 PM
OPINION

Editorial: Accountability for Hidden Local Debt Must Tackle the Root of the Problem

Photo: VCG
Photo: VCG

Despite the central government’s constant demand for regulatory accountability, the trend of loan violations in localities has not completely stopped.

Recently, the National Audit Office disclosed that the hidden debt of local governments in Hunan, Shaanxi, Heilongjiang provinces and the Guangxi Zhuang autonomous region had increased by 3 billion yuan (about $434 million) through various illegal methods. These illegal borrowings occurred after the July 2017 National Financial Work Conference, a key economic conference held every five years, which emphasized “strict control of local government debt increases, lifelong accountability, and investigations into responsibility,” but before the issuance of the “Local Government Implicit Debt Accountability Measures” in September of this year. How to deal with it has attracted people’s attention.

This problem — local governments pursuing development without adequate fiscal revenue to cover the cost — is not new. However, the risk of local debt accumulation has become one of the “grey rhinos” of the Chinese economy, and accountability is imperative. In order to cure this drawback, we should actively “open the front door” while “blocking the back door.” In other words, we must broaden formal channels for local financing, further deepen reform of the investment and financing systems, straighten out the financial relationship between the central and local governments, and accelerate the upgrading of government functions. Through this, we can simultaneously manage the symptoms and root causes of the hidden debt problem.

Since the end of 2016, the management of local government debt has entered a new phase under the guidance of a revised budget law. Through strict fiscal discipline, “opening the front door, blocking the back door,” and local debt replacement, the increase of debt has been strictly controlled and the debt is being actively reduced. However, although the “back door” is basically blocked, the “front door” — the formal debt channels — is not open wide enough to meet the financing needs of some places, especially underdeveloped areas. The size of special local bonds in 2018 increased to 1.35 trillion yuan, but it is far from meeting local demand.

In some places, there are cases that utilize various forms of illegal borrowing such as through loan contracts, financing platforms, PPP, government purchasing services, and selling public welfare assets. The methods for obtaining such loans have become more and more covert and the regulatory departments are thus playing a game of “cat and mouse.” Since the beginning of 2017, officials from local governments, financing platforms and relevant departments in more than 10 provinces have been held responsible for cities and counties under their jurisdiction engaging in illegal borrowing. The banking regulator and the finance, development and reform, and judicial ministries have also punished relevant financial institutions, law firms, and accounting firms. This shows the determination of the central government to uncover, investigate, and manage every case.

The reasons for local hidden debts are quite complicated. It is true that in some localities, politicians tried to borrow too much, going beyond what was financially available in pursuit of “political achievements.” Their “boldness” and enthusiasm was astonishing. High financial leverage has brought about great changes in cities and big upgrades in economic data. The local leaders have been in the spotlight and were praised by the people. Other places followed suit, but they have all completely ignored the issue of fiscal sustainability.

However, the deeper reason that many government departments in underdeveloped areas have the impulse to violate the rules and take on hidden debts is because of the juxtaposition of weak fiscal strength and strict financial expenditures. At present, downward pressure on China’s economy is increasing, and the financial situation in many underdeveloped areas is particularly difficult. Many local governments are facing the dilemma of maintaining growth and controlling hidden debts. The situation is difficult and deserves sympathy, but such actions are reprehensible.

The most worrying thing is that the real scale of local debt is completely unknown, and the calculations vary from place to place. At present, above-board local debt has been strictly managed in official budgets, but the scale of hidden debt has yet to be ascertained and managed. However, the size of hidden debts in various places is much higher than the explicit debts, which seems to be uncontroversial. Since 2017, the Ministry of Finance, the National Audit Office, the National Development and Reform Commission, and the financial supervision departments have carried out joint supervision to strengthen disciplinary actions against illegal and hidden borrowing, and achieved some initial results. Since August this year, the central government has issued two documents, “Opinions of the Central Committee of the Communist Party of China and the State Council on Preventing and Resolving the Implicit Debt Risk of Local Governments” and “Responsibility Measures for Hidden Debts of Local Governments.” A high-pressure situation has already taken shape. However, without institutional incentives to fundamentally eliminate illegal debt, localities will only further conceal their debts. Once a problem arises, the people and institutions involved will be spread far and wide.

At the root of the problem is the government’s soft budget constraints. To curb hidden debt at the source, officials at all levels should form a correct view of political achievements. More importantly, local governments must strengthen their budget constraints. Additionally, they must expand external supervision from local people’s congresses, improve auditing measures, increase supervision of the financial markets, and actively deepen reform of state-owned enterprises, breaking this “paternalism.”

It is imperative to form a standardized investment and financing system, to give localities more formal financing channels and to eliminate the need for illegal debts at the source of the problem. Along with this, we must speed up the reform of the fiscal and taxation systems, further clarify the responsibilities of the central and local authorities and expenditures, adjust the fiscal revenue and expenditure structure of the central and local governments, and open up more financial resources for local governments.

The transition of infrastructure financing to being publically financed has been promoted for about 20 years. However, the functions of governments at all levels to support infrastructure are still overly prominent. The “Government Investment Regulations” have been highly anticipated and have been brewing for nearly 20 years. The draft for comment has already been published. Every year, it is expected to be officially released. But so far, no results have been achieved. The biggest obstacle is that governments at all levels are reluctant to give up the hidden power behind infrastructure construction. In addition, some central departments do not consider the affordability of projects for local financial bureaus when formulating plans. In general, for government projects, central and local financial arrangements only account for 20% to 30% of the funds. Most of the funds need to be raised by local governments through other means. In the future, when formulating development and industrial plans, governments at all levels need to improve decision-making, do their best to avoid “one-size-fits-all” approaches, and, more importantly, promote the transformation of government functions to provide public goods with greater energy and financial resources.

Like many risks and contradictions in China today, the problem of hidden local debt is not purely a financial issue. It is a result of the failure to coordinate reforms in political, economic, and social arenas and a reflection of the process of modernization of the national governance system. The central government must prescribe medicine according to the symptoms. Otherwise, measures that appear to be resolutions will not address the root of the problem. While holding officials responsible, we should also pay more attention to solving deep-seated problems when disclosing and possibly discovering local irregularities in borrowing.

Translated by Ren Qiuyu (qiuyuren@caixin.com)

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