China’s illegal local debt pile grows as Beijing looks to infrastructure to buffer growth from US trade war
National Audit Office points to billions of yuan in new borrowings but this could be just the tip of the iceberg, analyst says
Despite direct orders from Beijing to cut leverage, China’s local governments continued to create illegal debt this year in part to offset the impact of the trade war with the United States, according to the National Audit Office (NAO).
In its second quarter review published on Tuesday, the NAO uncovered a further 8.9 billion yuan (US$1.3 billion) of implicit government debt created this year. The debt carries an implicit repayment guarantee from a local government entity even though such guarantees are illegal.
The continued growth in these borrowings highlights an ongoing challenge facing China and suggests the government might have to increase its intervention at the local level to stop the practice.
However, any attempt to clamp down on local government debt could also adversely affect financing for local infrastructure projects, a key part of the central government’s plan to stabilise the economy amid the trade war with the United States.
At the same time, local governments have received conflicting instructions from Beijing, with orders to both to cut back on implicit debt but also to find ways to fund the infrastructure projects needed to bolster growth.
Among the examples of illegal debt piles cited by the audit office was the 4 billion yuan in government funds that Yuhang district in the eastern city of Hangzhou borrowed and used to pay for to demolish housing and build roads, activities that were clearly commercial – and not municipal – in nature.
The administration of Yan’an New Area also illegally borrowed 1.18 billion yuan from a local financing vehicle to fund infrastructure construction.
Another 11 local authorities in six provinces were found to have inflated fiscal revenue by a total of 4.8 billion yuan. Among them, two county level governments in Guangdong province artificially increased the revenue by 3.2 billion yuan, by first distributing the funds to companies and hospitals and then collecting them back through fines or other fees.
The NAO said it would “push forward relevant regions to actively solve local implicit debt risks”.
Local cadres are usually motivated to grow the economy to gain promotion within the Communist Party system. But local governments often run short of revenues under the central government dominated fiscal system, so they resort to selling land or borrowing through local government financing vehicles to fund economic growth.
To help solve the local government funding problem, the Ministry of Finance has allowed local governments to sell bonds directly to the market since 2015. But the size of those bond issues is very limited compared to the country’s huge infrastructure funding demand.
The cases cited in Tuesday’s NAO report are believed to be the tip of the iceberg, since they come on top of numerous similar cases revealed in previous quarterly NAO audits and by the ministry in its investigations. The size of implicit debt accumulated in the past three years is estimated by private analysts to be 20-50 trillion yuan (US$2.9 trillion to US$7.3 trillion), depending on the precise definition of such debt.
Iris Pang, chief Greater China economist for ING Bank, said the NAO audits had, at best, merely scratched the surface and delivered a warning of the size of the problem.
“[In reality], there’s a tendency for local governments to turn to financing vehicles again [to fund infrastructure projects to stabilise the economy] amid the trade war with the United States,” she said.
In a meeting at the end of July, the Politburo, China’s top decision-making body chaired by President Xi Jinping, called on the government to take steps to stabilise the economy. An easing of some restrictions on borrowing by local government financing vehicles (LGFVs) has been evident since then.
Debt incurred by those vehicles is widely believed to be a large part of overall implicit government liabilities, although it is not included in official statistics.
“It remains a big question if [debt incurred by LGFVs] will eventually be repaid by local authorities. But many investors still tend to believe so,” Pang said.
In August, Beijing released national guidelines for investigating implicit local government debt and curbing its further expansion, accompanied by rules making local cadres personally accountable for any illegal local government borrowing. However, its full text has not yet been published.