The risks and solutions of local government hidden debts
Author: Tao Ran
Published in the 2023th issue of China Newsweek magazine on September 9, 18
After the 2008 international financial crisis, in order to alleviate the negative impact of the sharp decline in export growth on growth, the Chinese government carried out a round of large-scale fiscal and credit stimulus in 2009, and launched relatively strong macro policies in 2013~2014, 2016~2017, and 2020~2021 during three periods of growth pressure. These initiatives have led to the construction of extraordinary infrastructure across the country.
How do local government hidden debts form?
Based on "land finance", local governments have set up various types of financing platforms in the past decade to increase leverage and promote urban infrastructure construction with large-scale borrowing. For a time, various development zone and park platforms, transportation financing platforms, public utility financing platforms, land reserve centers, state-owned asset management centers, etc., have become the grip of hidden liabilities of local governments. Local governments generally allocate assets such as reserve land, equity in state-owned companies, fees, and treasury bond income to these platforms, and then obtain loans from banks or raise funds from the bond market by issuing urban investment construction bonds. Some cities, especially small and medium-sized cities in less developed areas, find it difficult to finance from the bond market due to insufficient credit, so they borrow from the shadow banking system at higher interest rates through financial leasing, project financing, trust private placement, etc.
In the past decade or so, many underdeveloped counties and cities in the east and central and western regions that were originally not superior in location conditions and had poor manufacturing bases have also begun to build new urban areas and industrial development zones on a large scale. In the five years from 2009~2013, China sold a total of 5,90 hectares of industrial and mining storage land with industrial land as the absolute main body, 7% higher than the 2004,2008 hectares in 56~62. In some provinces in the central and western regions that are not suitable for manufacturing, each county-level unit has built one or more industrial development zones, and many cities have also built new urban areas on a large scale. Now it seems that in many places, whether it is the development zone to attract investment or the goal of agglomerating the population in the new urban area, it has not been achieved.
According to the National Bureau of Statistics, China's infrastructure investment totaled $2010 trillion from 2020 to 108. In the past decade or so, various rounds of fiscal credit stimulus have been based on various traditional infrastructure and new infrastructure projects. Whether it is the construction of various new urban areas and development zones carried out by local governments, or urban road transportation (subway, light rail, large-capacity buses, etc.), urban pipe networks (water supply, sewage, rainwater, gas, heat supply, communications, power grids, drainage and flood control, flood control and urban underground comprehensive pipe gallery pilots, etc.), sewage and garbage treatment, ecological garden construction projects, the construction standards and costs are quite high, and many of these infrastructure projects can only generate little or no cash flow. In the future, the principal and interest can only be repaid through government revenue.
The consequence of this large-scale infrastructure construction is that local government debt has exceeded 2008 trillion yuan by the end of 5 from 2010 trillion yuan in 10, and has continued to increase since then, and has now reached a super high level. According to the International Monetary Fund's estimates, local broad-caliber debt (implicit plus explicit debt) will be about 2021 trillion yuan in 80. By the end of 2022, local explicit debt (general debt plus special debt) will be 35 trillion yuan, local investment and financing platform debt will be 59 trillion yuan, a total of 94 trillion yuan, although the debt of local platform companies should not be counted as local hidden debt, but because the liabilities of some unissued urban investment companies are not fully included in the statistics, and the loans of some local non-urban investment state-owned enterprises are actually local government debts, I estimate that the total local debt should be at the level of 90 trillion yuan.
Debt swapping and local government releveraging
If the local government's broad-caliber debt is 90 trillion yuan, even after debt replacement and interest rate reduction after 2015, the average interest rate of existing debt should be 4%~5%. This means that local governments need to pay at least 3.6 trillion yuan ~ 4.5 trillion yuan in interest every year.
As we all know, the main source of local government debt repayment is land transfer, and the gross income of local land transfer was 2020.8 trillion yuan in 4, and fell sharply after reaching a historical high of 2021.8 trillion yuan in 7, and only 2022.6 trillion yuan in 7, and is expected to decline further this year. However, the above-mentioned land transfer fee is only gross income, and it is only net income after deducting land acquisition, demolition compensation and infrastructure construction costs. In good years when house prices and land prices have been rising, the net income of land transfer is basically 20%~25% of gross income. Now this proportion is estimated to have dropped significantly, reaching 10%~15% at most, and some cities should be less than 10%.
Many third- and fourth-tier cities with outflow of population, and even some second- and third-tier cities with over-construction and over-debt, not only have the proportion of net income from land transfer money decreased significantly, but the total amount of land transfer has also dropped significantly, but the local stock debt is quite high. Therefore, the net income from local land transfers, and even other income that can be mobilized to repay debts, is difficult to cover the interest on local debts, and can only borrow new to repay the old, continue to extend, or even default. Some cities have begun to have problems even ensuring the basic operation of the government.
In order to alleviate the local debt problem, the central government carried out a round of debt swaps after 2015, through the issuance of local government bonds with lower interest rates by provincial governments to replace some of the debts of urban investment companies with higher interest rates. This measure does give local governments some breathing room, but it does not appear to be fully curbing the further increase in local debt.
After 2015, some local governments borrowed in disguise through three new models: PPP, government investment funds, and government procurement of services. Taking PPP as an example, after the official allowed private capital to participate in the construction and operation of urban infrastructure through franchising, relevant ministries and commissions issued a large number of policy documents aimed at regulating and promoting the PPP model.
However, in practice, these large-scale PPP projects intended to attract social capital basically do not absorb too much social capital, and most of the projects are obtained by central enterprises, the key to which is that many central enterprises can obtain credit resources, and as a result, many such projects have been alienated from "public-private partnership" to "public-public-private partnership": that is, led by local governments. Led by central SOEs and local platform enterprises, local platform enterprises and central SOEs jointly borrow money from state-owned financial institutions, and their central SOEs complete financing that local governments cannot complete, but a significant proportion of the project is eventually subcontracted to private contractors. As a result, many PPP projects are paid entirely by local governments, private capital does not participate in the demonstration, design, construction and operation of projects, and local governments promise to bear the responsibility of repaying principal and interest by buying back shares and paying fixed income, which forms new hidden debts of local governments.
In practice, local governments tend to have a high incentive to build new roads, bridges, ports, and other easily identifiable infrastructure investments, and tend to artificially expand the scale and construction standards of these projects. Obviously, compared with investing in human capital (basic education, public health, etc.) or other social and public services, investment in physical infrastructure is more likely to directly drive economic growth, more likely to obtain short-term visible construction results, and easier to create rent-seeking opportunities.
It is easy to observe in recent years that many public projects increase the complexity of the project and the standard of construction as much as possible to increase the cost, and the key is the rent-seeking space. The Central Commission for Discipline Inspection once pointed out, "In recent years, many provinces, cities and counties have established local state-owned platform companies such as 'urban investment', 'transportation investment', 'water investment' and 'cultural tourism investment', which have played an important role in local economic development." However, some platform companies deviate from the original intention of establishment, and some take advantage of the advantages of government projects, policy preferences, and concentrated funds to operate in the dark in project contracting; Some eat kickbacks and interest spreads in the process of financing and borrowing; Some fraudulently use their identities to contract at low prices and lease at high prices in land consolidation operations, enriching their own selfishness. "As a result, 2020% of the corruption cases investigated and dealt with in some counties in 70 occurred in platform companies. As an economic entity that mainly undertakes the financing function of government investment projects, investment and financing platform companies have become "enrichment areas" with relatively concentrated public resources such as funds, land and equity, and are also "high-incidence areas" for problems such as illegal financing guarantees, illegal borrowing, and illegal borrowing investment.
At the same time as the debt reduction, we must promote market-oriented reforms
The key problem with the rapid increase in local government debt over the past decade or so is that even after the implementation of the new budget law, the problem of local government budget constraints has not been resolved.
To effectively solve the local debt problem, the central government should resolve to promote nationwide local debt restructuring as soon as possible when the risks are still under control, and promote fiscal restructuring as soon as possible in places where interest cannot even be repaid. This means that on the basis of a comprehensive understanding of the local debt stock, the central government should make overall plans and take various measures to carry out fiscal restructuring for local governments that are too indebted and difficult to pay interest. Local government departments must make every effort to reduce staff and increase efficiency, local fiscal revenue can only be used to ensure basic operation and basic people's livelihood expenditure, and the rest of the funds must be used to repay debts. In this process, relevant departments may also have to negotiate with creditors, mainly banks, to reduce and extend the interest rate of some local debts, so as to create conditions for the central government to formulate a national debt restructuring plan and ensure the bottom line of national economic and financial security.
In short, while launching the "package of bonds" as soon as possible, it is necessary to enhance the confidence of market entities by promoting market-oriented reforms as soon as possible, stimulate economic growth, reduce the production costs of enterprises and the living and living costs of the people while increasing employment, and finally reduce the proportion of non-performing debts by enlarging the total amount of the national economy, enlarging the total assets of the financial system, and increasing fiscal revenue, so as to resolve risks and ultimately achieve long-term prosperity of China's economy.
(The author is a professor and director of the Department of Public Policy, School of Humanities and Social Sciences, Chinese University, Hong Kong)
The views expressed in this article are those of the author only
China Newsweek, Issue 2023, 35
Disclaimer: The publication of China Newsweek manuscripts is authorized in writing