Aug 06, 2019 04:21 AM

Editorial: Local Debt Risks Remain a Chronic Disease

Photo: Bloomberg
Photo: Bloomberg

The issue of local debt has once again returned to the public eye. Recently, Jiangsu, Zhejiang Shandong and other provinces published their annual audit reports for 2018, reminding us of debt risks – particularly implicit debt risks. There are many problems in these areas, such as the unscientific progress in debt resolution, the difficulty implementing debt conversion schemes, turnover between new borrowing and old loans, the slow transformation of financing platforms, and inaccurate data on implicit debts. This is still true in advanced eastern regions, and the situation in central and western provinces can be imagined. It is imperative to deeply understand the hotbeds of institutional mechanisms that breed local debt, especially recessive debt, and to eradicate persistent soft budget constraints.

In recent years, officials have talked less and the media have reported less about the issue of local debt, as if the risk has been controlled. It should be said that since the implementation of the State Council’s “Opinions of Strengthening Local Government Debt Management” in 2014, the out-of-control local debt has been significantly curbed. According to the central government’s plans, the National Financial Work Conference in July 2015 marks a boundary. The implicit debt borrowed before then is the implicit debt in stock. It will be gradually resolved within five to 10 years, and no new implicit debt will be added thereafter. However, the newly released audit reports show that preventing and resolving local debt is still an arduous task, hidden debt is still growing latently, and the methods for borrowing are constantly changing. Local debt is still a serious problem for China’s economy.

Finding out how deep the debt goes is key to resolving the implicit debt stock. Since the National Audit Office twice audited local debt, no authoritative or detailed data on the scale and structure of local debt has been published. No department can completely and truly grasp the scale of implicit local debt, let alone effectively prevent and manage the risks of local debt. In the next few years, local debts will enter the period of peak repayment of principal and interest due, adding to downward pressure on the economy. This risk cannot be underestimated. The most worrying thing is not the tens of trillions of yuan of debt itself. Rather, it is the soft budget constraints at the crux of all kinds of explicit and implicit debt.

Soft budget constraints by definition are the consistent disregard of capital and cost constraints in investments. Then, when financial distress occurs, the local government expects to be rescued. This was a typical feature of the planned economy. During the transition period, as the budgetary constraints of micro-market subjects are hardening, governments at all levels and in all institutions with government relations still suffer from this problem but in different forms and to different degrees. This is the case with financial institutions that “transfuse” local debt. Local “GDP Championships” and incentive mechanisms for officials, the mismatch between the expenditure responsibilities of central and local powers, etc., make this stubborn problem worse. Governments suffering from “investment hunger and thirst” try their best to increase GDP. They borrow heavily but do not worry much about the consequences of a surge in debt. Debt risk passes from old officials to new officials. The central government has repeatedly stated that it will not completely cover local debts. However, local governments believe social stability is a top concern for the central government and it will not fold its arms and look on, so it is very difficult for such warnings from the central government to carry real weight. Eventually, the “soft budget constraint community” will include governments at all levels, related financial institutions, enterprises, and investors.

The central government attaches great importance to the risks of local debt and has issued one policy document after another. However, the pattern of implicit local debt is constantly changing, from local financing platforms to PPP (public-private partnerships, or cooperation between government and social capital), to government purchasing services and industrial funds. When the PPP policy was introduced, the finance department anticipated that local governments might use PPP as another financing tool and formulated policies to prevent this. Even so, it could not be avoided. This only makes people wonder about the deeper reasons behind it.

Soft budget constraints are symptoms, however. They are the consequence of failing to coordinate reform in various fields. Nowadays, the mechanisms of power delegation, application, and restraint of government at all levels is far from what is needed to modernize the national governance system. The control of local debt mainly depends on administrative means. The information asymmetry between the principal and the agent cannot be eliminated without full use of the supervision of the public, the market, and public opinion. In recent years, there have been sporadic incidents of minor sanctions against local officials who borrow money in violation of regulations. However, compared with the prospects of promotions based on GDP performance, and with the likelihood of punishment very small, it is not difficult for local officials to make “rational” choices.

To curb the mechanisms that cause the continuous growth of local debt and eradicate the chronic disease of soft budget constraints, we must deepen the reform in an all-around way and make comprehensive efforts at an institutional level. In addition to speeding up the transformation of government functions and continuing to push forward the transition from construction finance to public finance, we should also straighten out intergovernmental financial relations and establish a debt system for every level of government. We should reform and improve the mechanisms for assessing local government performance and officials so as to achieve timely accountability and the finalization of new debt. The external supervision of local governments’ uncontrolled and irregular borrowing behavior must be strengthened along with the joint supervision mechanisms across departments, giving full play to the supervisory responsibilities of local people’s congresses, audits, and other supervisory functions of the public and public opinion. It is also necessary to continue “opening the front door while blocking the back door,” speed up the dissolution of debt stock, and resolutely curb the debt increment. We should gradually absorb the huge amount of local debt that we already have. These goals have long been established, but need to be put in place, showing again that “comprehensively deepening reform” is not just a slogan. Slow reform will have serious consequences.

In recent years, most of the analysis and research on local debt has focused on risk assessment, but little is known about how to restrain the growth momentum of local debt by using institutional mechanisms. The theoretical analysis is not profound, but there are a few important measures to improve, which reflects a dilemma. It is obviously more advisable to control the situation through administrative means, promote institutional change with greater strength and eliminate soft budget constraints.

You've accessed an article available only to subscribers
Share this article
Open WeChat and scan the QR code