(Bloomberg) — There are growing signs in China that local government debt is becoming unsustainable.
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China’s 31 provincial governments have outstanding bond reserves approaching the Ministry of Finance’s risk threshold of 120% of revenues. Breaking that line could mean sectors face more regulatory barriers to borrowing, further hampering their ability to drive economic growth.
In addition, local authorities will face a massive maturity wall over the next five years as nearly 15 trillion yuan ($2.1 trillion) in bonds – more than 40% of their outstanding debt – are due.
While there is little risk of provincial governments defaulting, they will find it increasingly difficult to service their debts. More and more bonds would have to be sold to mature rather than fund new spending, and investment growth could be affected as a result.
One of the main causes of the economic crisis is the wealth crisis. Revenue from land sales – which historically accounted for about 30% of local government revenues – has plummeted. In addition, trillions of yuan in tax breaks have been given to companies in recent years to help the economy cope with the downturn.
The central government recently acknowledged its concern about special local bond repayment risks for the first time and urged Shenzhen, the technology hub that is next to Hong Kong, to consider setting up a provision fund to cover debt payment risks. Shenzhen’s finances are in better shape than many other cities or provinces, and it’s something of a testing ground for fiscal reform.
At an October meeting of the Standing Committee of the National People’s Congress, the country’s parliament, some representatives warned that local government debts due to expire in the coming years would be “difficult to pay as planned.” He called for emergency plans to be made soon.
Economists such as Ding Shuang of Standard Chartered Plc believe that the national government should shoulder the burden of debt by borrowing more. Yu Yongding, a former central bank adviser, and other economists made a similar call in a report earlier this month, suggesting that the central government should sell more debt, especially common bonds, which are used to invest in infrastructure .
“It should be the central government, rather than the provinces, to exert influence – regional finances have weakened significantly in recent years,” Ding said. “The government will come under increasing pressure to make changes. it’s a matter of time.
China has set the exposure limit for provincial debt at 120% of its “expanded financial resources” – generally considered to be the combined revenues from the general government budget and the government fund budget, plus transfer payments from the central government. At.
Prior to 2020, the ratio was fairly stable, with debt restrictions from Beijing helping to lower it somewhat. The ratio has since risen as the government delivered fiscal stimulus during the pandemic. Provincial debt rose from 83% in 2019 to 118% of income at the end of September, according to Bloomberg calculations based on official data.
In contrast, local government revenues have fallen significantly, mainly due to declining properties and declining land sales. Annual growth in total local income weakened to just 2.5% last year, compared to 7.1% in 2019 and double-digit growth in the previous two years.
“Governments’ markedly faster growth than their fiscal resources means their debt burdens will continue to mount,” Yiwei Yang, chief bond analyst at Guosheng Securities Co., wrote in a November note. “This will pose new challenges for fiscal policy and fiscal health and stability going forward.”
According to a report from the Treasury Department, the high-risk sectors will have to limit the size of their investment projects, reduce government spending and divest assets to bring total borrowing below the threshold. Some provinces, such as Anhui in central China, have already taken steps to ban riskier areas from adding new loans.
The fastest growing portion of the county’s debt pool is specialty bonds. These are funds raised primarily to finance infrastructure investments, which help drive economic growth. Nearly 11 trillion yuan worth of new special bonds have been issued since 2020, more than doubling what has been sold in the five years since 2015, when local governments were first allowed to self-issue the banknotes.
The coming year will be particularly challenging for local government finances. About 3.65 trillion yuan in bonds due in 2023 is a record high for any year and an amount equal to this year’s new quota for special bonds.
Even the payment of interest is a growing problem. Interest payments on special bonds reached 479 billion yuan in the first nine months of the year, equivalent to 6.2% of government fund spending. Levels above 10% would trigger financial restructuring — as happened in the city of Hegang late last year — under rules published in 2016, forcing local governments to pull their pockets, including freezing hiring.
If the central government were to issue more regular bonds to finance infrastructure projects, it would have to increase the official budget deficit from its current level of around 3% of GDP. The official deficit has been kept low as the government is cautious about expanding general bond sales and prefers to let the provinces issue as many special banknotes as possible.
Standard Chartered’s Ding estimates that the overall budget deficit will reach 7.3% of GDP this year if special local bonds are included.
“Such a high ratio is unsustainable,” he said.
– With help from Helen Sun.
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