Caixin
Dec 24, 2021 09:14 PM
OPINION

Opinion: How China’s Local Governments Can Cut Their Debts

In the past decade, Chinese local governments’ fiscal expenditures were generally larger than their revenues, and the gap between revenue and expenditure has been expanding year by year. Faced with an aging population and the pandemic, the proportions of local expenditures on social security and public health both continue to rise, while the gap between local government revenues and expenditures continues to widen as the proportions of both tax revenue and land revenue shrink. Therefore, some local governments operate through deficit spending and borrowing.

As of October, China’s local government debt balance — excluding local government financing vehicles’ (LGFVs) debts — had registered 29.65 trillion yuan ($4.7 trillion). The debt increase was mainly due to the expansion of local special-purpose bonds. In the past three years, both the outstanding balance and growth rate of local government bonds were significantly higher than those of LGFV debts.

 

Last year, only Shanghai, Guangdong, Beijing, Zhejiang and Jiangsu had government debt-to-fiscal revenue ratios below the risk threshold of 100%; Qinghai, Heilongjiang, Ningxia and Inner Mongolia had ratios of more than 300%, with Qinghai even exceeding 500%. If implicit debts such as LGFV debts are taken into account, only Shanghai and Guangdong had debt ratios below 100%.

Given their economic growth pattern and industrial structures, there is not much room for increasing revenue for Heilongjiang, Qinghai, Ningxia, Inner Mongolia and other provincial-level regions with high debts. Cutting down on expenditures is the main way for these local governments to reduce debt pressures. Based on the structure of expenditure in these regions, the only way to alleviate debt risks is to reduce the general public service expenditures by reducing unnecessary infrastructure expansion, and to improve the efficiency of investment in infrastructure and public transport.

Expenditures exceed revenue

From 2011 to 2020, China’s local fiscal expenditures exceeded revenues, and the gap between them widened year by year. Starting from 2015, the growth rate of local government expenditures exceeded that of revenue, resulting in a rising revenue-expenditure disparity. In 2020, the local general public budget expenditures were 21 trillion yuan, a year-on-year increase of 3.4%; the increase of expenditures slightly slowed, but the actual deficit was still as high as 2.7 trillion yuan.

 

China’s local public fiscal revenue comes mainly from tax revenue and funds allocated by the central government. In 2020, the local tax revenue was 7.5 trillion yuan, 3% lower than the previous year, accounting for 41% of the whole country’s public fiscal revenue. The decline was largely attributed to the tax base reduction triggered by the outbreak of Covid-19 and tax and fee reduction policies.

In local fiscal revenue, tax revenue accounted for 75%. After the comprehensive implementation of replacing business tax with value-added tax (VAT), the main sources of local governments’ tax revenue have been VAT and corporate income tax.

In addition, the local governments that could not make ends meet enjoyed additional funds — accounting for a large share of their revenues — from the central government. In 2020, local governments received 8.3 trillion yuan from the central government, up 11.9% from the previous year, accounting for 45% of the local fiscal revenue. Statistics show that, although the central government’s fiscal revenue was in surplus after deducting its own expenditure, the surplus could not cover the funds allocated to local governments. Thus, the central government was also in the state of “spending more than what it collects.” In 2020, the Chinese central government’s public fiscal revenue reached 8.3 trillion yuan, and fiscal expenditure registered 11.8 trillion yuan, with a revenue-expenditure gap of 3.6 trillion yuan. Of the central government’s revenue, 96% came from tax revenue, of which VAT accounted for 35.6% and corporate income tax 29.1%, while in the expenditure, more than 70% was funds transferred to local governments.

 

As the main revenue source of government-managed funds, land sales revenues are an important source of revenue for local governments. In the last decade, the annual growth rate of land sales revenues fluctuated greatly from -23.8% to 46.6% due to regulatory changes. This has resulted in significant fluctuations in the revenue of government-managed funds.

From 2011 to 2020, the share of expenditure on social security and employment rose from 11% to 15%, and that on public health increased from 7% to 9%, but the share spent on general public service dropped to 9% from 11%. In 2020, the expenditure on education, and social security and employment reached 3.5 trillion yuan and 3.1 trillion yuan, respectively. While local governments continued to spend on infrastructure (energy conservation and environmental protection, urban and rural development, agriculture, forestry and fishery, and transportation), they focused more on improving people’s livelihood.

In addition, in the past decade, local government expenditure on debt interest payments grew the fastest, followed by the expenditures on social security and employment. Public health expenditure came in at third place.

Confronted with an aging population and the pandemic, the proportions of local expenditures on social security and public health both continue to rise, while the gap between local government revenues and expenditures continues to widen as the proportions of both tax revenue and land-related revenue shrink. Therefore, some local governments operate through deficit spending and borrowing.

Reducing expenditures to dissolve debt risks

As of October, the outstanding debt of the country’s local governments had reached 29.7 trillion yuan (excluding LGFV debts). The expansion of local special-purpose bonds was the main reason for the growth in local government debt. In the past three years, both the outstanding balance and growth rate of local government bonds were significantly higher than those of LGFV debts.

 

Last year, only five provincial-level regions had government debt-to-fiscal revenue ratios below the risk warning line of 100%, namely Shanghai (67%), Guangdong (71%), Beijing (78%), Zhejiang (79%) and Jiangsu (84%). On the other hand, the debt ratio of Qinghai province exceeded 500%, and those of Heilongjiang, Ningxia and Inner Mongolia were higher than 300%. If the LGFV debts are taken into account, only Shanghai and Guangdong had debt ratios lower than 100% in 2020 (85% and 90% respectively), while Qinghai’s debt ratio was as high as 540%.

The governments in China’s underdeveloped areas are heavily indebted. This is because of slow economic development, a lack of resources to boost government revenue, as well as the low administrative efficiency and redundant government staffing.

In 2020, the proportions of expenditure on general public services in Qinghai, Heilongjiang, Ningxia and Inner Mongolia were higher than that in Shanghai. Taking Qinghai as an example, of the basic expenditures on the provincial government’s own general public budget, 60.9% or 3.2 billion yuan was spent on goods and services consumed by the government, while the percentage in Shanghai was 21.9%. This shows that the government of Qinghai should save administrative expenditures to reduce its debt risk. Similarly, the absolute amount of expenditure on general services in Inner Mongolia was even higher than that of Shanghai, indicating that there is still much room for the government of Inner Mongolia to reduce expenditure on administrative operations.

Furthermore, Qinghai, Inner Mongolia and Ningxia made big investments in transportation (infrastructure), which represented 12.3%, 6.4%, and 6.1% of their public fiscal expenditures, respectively. These shares were all higher than the average share (4%) of eastern provinces with low debt ratios. In 2020, Qinghai invested 162.4 billion yuan in toll road construction. That same year, its income from and expenditure on tolls were 1.6 billion yuan and 5.1 billion yuan respectively, with a gap of 3.4 billion yuan. Thus, we suggest the expansion of local infrastructure projects should be based on practical benefits and returns.

Lin Caiyi is a deputy director of the research institute of the China Chief Economist Forum. Zhang Jing is a researcher at the institute.

This article has been edited for length and clarity.

Contact editor Bertrand Teo (bertrandteo@caixin.com)

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