In Depth: Clearing Arrears to Businesses Tests Chinese Localities’ Resolve

Beijing has intensified efforts to resolve substantial local public-sector arrears owed to businesses, raising both hopes and concerns among stakeholders. The primary apprehension is whether localities, many already under financial pressure, will be willing or able to assume new, interest-bearing debt to eliminate existing interest-free obligations[para. 1]. This reticence persists despite some recent progress, as the overall financial health of local governments remains fragile, influenced by strict rules introduced in 2023 to curb hidden debt and compounded by several years of economic headwinds[para. 2][para. 3].

The accumulation of arrears has been aggravated over the past three years by the impact of the Covid-19 pandemic and a broader structural economic slowdown in China, both contributing to persistent fiscal stress for local governments[para. 3]. In response, a significant initiative was led by the Ministry of Industry and Information Technology (MIIT) in 2024. The ministry was responsible for compiling a comprehensive list of arrears while mandating six categories of public entities—including government agencies, state-owned enterprises (SOEs), government financing vehicles (LGFVs), and multiple types of public institutions—to report all outstanding arrears as of June 30, 2024. These entities were also instructed to repay as much of these debts as feasible[para. 4].

The Chinese central government has established a timeline for completing the arrears-clearance campaign by June 2027, with an initial push to clear all arrears under 500,000 yuan by September 2024 and encouraging full payment in provinces with lower levels of arrears by year-end[para. 5][para. 6]. It is estimated that government arrears could reach about 4.5 trillion yuan ($632 billion) in 2024, representing over 3% of China’s GDP, according to China Chengxin International Credit Rating Co. Ltd.[para. 7].

A critical component of the campaign has been fiscal support from the Ministry of Finance (MOF), primarily via local government special-purpose bonds (SPBs). The MOF earmarked 200 billion yuan from the 2024 SPB quota specifically to repay arrears owed by government agencies and public institutions, with around 151 billion yuan already allocated across at least eight provinces[para. 8][para. 9][para. 10][para. 11]. Notably, Yunnan province—a region identified as a high debt risk—accounts for nearly a quarter of these earmarked funds[para. 12].

This year marks a shift in how SPB proceeds are managed: an independent quota has been established for repaying arrears, avoiding previous issues with fund mixing, and the funds are allocated so as not to cover hidden local government debt[para. 13].

In addition to bond financing, China’s 18 national commercial banks, including both state-owned and joint-stock lenders, have been tasked with supporting repayment by providing loans to local SOEs, LGFVs, and public institutions that operate with their own revenue streams. The total arrears owed by these sectors is estimated at 1.8 trillion yuan[para. 14]. Recent policy changes allow these entities to use bank loans as working capital to repay arrears from project construction, previously a prohibited use, with strict oversight ensuring funds go directly to creditors to prevent misappropriation[para. 15][para. 16][para. 17].

Despite these efforts, the scale of actual loans extended is expected to be limited, as many SOEs’ arrears are tied to projects on behalf of local governments, raising concerns about inadvertently creating more off-the-books government debt, which is discouraged by regulation[para. 18]. Due diligence remains with the banks, and early indications suggest only a small number of loans will be viable, given that some SOEs lack independent revenue[para. 19].

In summary, while Beijing has orchestrated a multifaceted approach involving fiscal allocations and targeted bank lending to address the mounting arrears, the intrinsic weakness of local finances and regulatory constraints pose significant challenges to resolving the issue completely within the established timeline[para. 1][para. 2][para. 3][para. 4][para. 5][para. 6][para. 7][para. 8][para. 9][para. 10][para. 11][para. 12][para. 13][para. 14][para. 15][para. 16][para. 17][para. 18][para. 19].