Caixin Explains: How and Why China’s Local Government Debt Got So Big
Most governments around the world are in debt, but the problem in China has been a major risk flagged by economists and multilateral institutions like the International Monetary Fund (IMF) for several years.
Two big concerns in China are — first, the speed at which local government debt has grown since the global financial crisis began in 2008, and second, the unknown scale of the liabilities hidden off-balance sheet in local government financing vehicles (LGFVs).
Policymakers have been trying to grapple with the problem for almost a decade amid mounting concerns that borrowings were spiralling out of control and contributing to growing risks in the financial system.
An investigation of the finances of local governments across the country published by the National Audit Office (NAO) in December 2013 estimated their total debts had surged to 17.9 trillion yuan ($2.66 trillion) by June that year from 10.7 trillion yuan at the end of 2010, when the first audit was carried out, and just 1.7 trillion yuan in mid 2008.
Most of that debt wasn’t officially on the books of the local authorities themselves, but was hidden in LGFVs, companies set up specifically to borrow the money needed to fund trillions of yuan of spending on infrastructure and other public welfare projects. LGFVs have played a key role in raising money to fund and build government-backed projects since 2008 when the central government pushed local authorities to ramp up investment to cushion the economy from the global financial crisis and boost growth. If those vehicles failed to repay their borrowings, local governments were on the hook for the money.
The root of the problem can be traced back to an overhaul of the fiscal and taxation systems in 1994 which changed how fiscal revenue and spending responsibilities were split between central and local governments. It strengthened the central government’s control over money raised but forced local authorities to assume the lion’s share of the cost of public services.
With less money in their pockets, and dependent on the redistribution of fiscal funds from the center, many local authorities struggled to fund their spending from the resources they had, a problem exacerbated by a ban on raising money through bond sales and bank loans. Faced with requirements to support infrastructure investment to meet the central government’s growth targets, and pay for all the new health, pension and welfare benefits introduced by the previous administration of former President Hu Jintao, many local authorities turned to a range of innovative fundraising channels, including borrowing heavily through LGFVs.
But by 2013 policymakers realized that local government borrowing had become a risk to the stability of the financial system. They embarked on a strategy not only to stop the debt from growing further but also to bring more transparency to, and accountability for, the liabilities and clean up the complex, hidden web of transactions that could trigger a crisis if they unwound in a disorderly manner.
In an effort to make local government debt more transparent, a new Budget Law took effect at the start of 2015 which officially revoked a 20-year ban on bond issuance by local authorities. Local governments were also permitted to swap about 14 trillion yuan of LGFV debt into bonds over a period of three years starting from 2015, and a series of regulations were issued to rein in LGFV debt and control how and for what purpose local governments were allowed to borrow.
A total of 12.2 trillion yuan of bonds have been sold under the debt-to-bond swap program, according to an NAO report (link in Chinese) in December. The Ministry of Finance said that at the end of 2018, official local government debt — the explicit liabilities on their books — was 18.4 trillion yuan (link in Chinese) including the swap bonds, amounting to some 20% of gross domestic product (GDP).
Explicit government debt — at both the local and central level — as a percentage of GDP jumped from 16% in 2013 to 36.9% at the end of 2017 as a result of recognition of debt swapped into bonds, according to the IMF, which expects the figure to jump to 43.2% in 2023. But the IMF estimates that once the off-budget borrowings of local governments and LGFVs are taken into account, the government debt-to-GDP ratio will have grown from 48.1% of GDP in 2013 to 91.6% in 2023.
The debts of the LGFVs are still ballooning. Although the government hasn’t officially revealed the scale of these hidden liabilities, unofficial estimates put the total as high as 45 trillion yuan.
An analysis by Rhodium Group, a New York-based research provider, estimated total LGFV debt at 41.8 trillion yuan as of July 2018, although only 30 trillion yuan of which was implicit debt that local governments had the liability to repay.
Contact reporter Fran Wang (email@example.com)
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