Finance Officials Sound Alarm Over Surging Local Government Debt

Current and former officials of China’s finance ministry raised alarms over risks posed by surging local government debt, calling for greater control over borrowing and for giving authorities more flexibility in the sources of revenue they can use to repay bonds.

The value of outstanding local government debt is expected to reach 26 trillion yuan ($4 trillion) by the end of 2020, Xue Xiaoqian, deputy director of the Ministry of Finance’s China Government Debt Center, told a forum Tuesday. That’s an increase of 22% (link in Chinese) since the end of 2019, when the figure was 21.3 trillion yuan, and is up from 16.5 trillion yuan (link in Chinese) at the end of 2017, the year the government embarked on a campaign to curb financial risks.

Xue said the overall ratio of outstanding debt to local governments’ “comprehensive financial resources” –– mainly on-budget local fiscal revenue, tax refunds, transfer payments from the central government, land sales and some off-budget revenue –– is now approaching 100%, which he described as the lower limit of a warning range. The ratio was 82.9% at the end of 2019, finance ministry data show (link in Chinese).

Risks from the accumulation of debt are rising as local governments are hit by slowing economic growth, the fallout from the Covid-19 pandemic, the central government’s policy of cutting taxes and fees and weaker revenue from land sales. These negatives are eating into fiscal revenue at the same time spending pressures are growing as local governments are being called on to bolster economic growth through infrastructure spending and find money to bail out local state-owned enterprises and banks.

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Overall local government fiscal revenue fell 12.3% (link in Chinese) year-on-year in the first quarter when China’s Covid-19 outbreak was at its peak, although the decline narrowed to 3.8% (link in Chinese) in the first nine months, ministry data show.

The Ministry of Finance’s 2020 limit for new general-purpose bonds was set at 980 billion yuan, up from 930 billion yuan in 2019. Local governments were also allowed to raise 3.75 trillion yuan from the sale of special-purpose bonds (SPBs), almost 75% more than 2019’s quota of 2.15 trillion yuan.

SPBs provide local governments with a source of cash to fund infrastructure and other public welfare projects that are commercially viable. The borrowings are meant to be repaid from income generated by the projects they invest in, while general-purpose bonds are usually repaid from government fiscal revenue.

Once the economy recovers, local government debt needs to be brought under control and leverage ratios kept stable within a reasonable range, Xue said. SPBs should be gradually reined in to prevent local governments from becoming dependent on them and to reduce debt risks. Local governments should also be given more options to repay SPBs, Xue said. He called for better risk prevention and control of individual projects funded by SPBs.

Zhang Hongli, a former vice minister of finance, pointed out at the forum that even before the pandemic, some local governments were struggling to repay bonds, especially as the growth in revenue from land sales has been declining. Some authorities in the less developed western and northeastern regions have seen their outstanding debts rise to more than double their annual fiscal revenue, he said.

Local governments are increasingly dependent on rolling over their bonds –– 92% of the 310 billion yuan of SPBs that matured in the first eight months of 2020 were repaid using money raised from the sale of new SPBs, he said.

Zhang also called for the introduction of long-awaited reforms to the fiscal relationship between the central and local governments, which many experts say lies at the root of local government financing problems. Local governments are responsible for around 80% of national fiscal spending but receive only around 50% of fiscal revenue, a result of a reform of the fiscal system in 1994. But that has left local authorities shouldering a disproportionately high level of spending, which has contributed to the buildup of debt.

Zhang said the problem of mismatch between local financial resources and expenditure responsibilities must be resolved and called for an early warning system for local government debt in addition to strengthening performance management of fiscal spending.

This story has been updated to correct the name and title of Xue Xiaoqian. Xiao is the deputy director of the Ministry of Finance’s China Government Debt Center.

Contact reporter Luo Meihan (meihanluo@caixin.com) and editor Nerys Avery (nerysavery@caixin.com).

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