Fears over China’s ability to manage its domestic economy alongside the trade war with the United States have further increased after 30 of the 31 provincial level governments are reported to have ran at a deficit in the first six months of 2019. Shanghai was the only authority that ran a surplus financial position in the first six months of the year. This follows the takeover of Baoshang Bank in May and the bailout of the Bank of Jinzhou last week, and has increased the speculation over how many regional banks and even local governments are in need of help from Beijing and if they will be classified as “systemic risks” to the world’s second biggest economy. “We don’t expect a banking crisis, but see extensive recapitalisation and consolidation [of the banking sector] as inevitable,” said Diana Choyleva, chief economist of the London-based consultancy Enodo Economics. We don’t expect a banking crisis, but see extensive recapitalisation and consolidation [of the banking sector] as inevitable Diana Choyleva In addition, “debt as a share of [gross domestic product] is set to rise again, an unwelcome trend. China has scope for one more credit-driven stimulus, but that’s all – unless it fundamentally changes its economic model.” It is common for some local authorities to report initial deficits under China’s fiscal system, in which Beijing takes the majority share of revenue and then remits funds to local governments to cover their deficits. But it is also an open secret that many have significant revenue shortfalls and large spending excesses due to tax cuts and infrastructure spending mandates from the central government. These local governments are now scrambling for permission to issue new bonds and to take out new bank loans to fund industrial, infrastructure and social projects. Last month, the central province of Hunan signed a comprehensive cooperation agreement with the state-owned China Construction Bank and received a 2 trillion yuan (US$288 billion) line of credit for the next five years. It will be used to support local manufacturing, to cultivate new technology enterprises and to “address the implicit debt” of the province, according to an official statement. So once again here we have the big five banks bailing [local governments] out Fraser Howie The deal came just weeks after the Fujian provincial government signed a similar agreement with the Bank of China, another state-owned lender, and obtained a credit line of 500 billion yuan (US$72 billion). The Industrial and Commercial Bank of China, which is China’s largest lender, promised in July to lend up to 150 billion yuan (US$22 billion) to the Yunnan provincial government over the next five years. China’s provincial and municipal governments have long been ridden with debt with a confirmed total of 20 trillion yuan (US$2.9 trillion), but they are suspected to also be holding tens of trillions of yuan in hidden, off-budget debt obtained through a variety of financial vehicles and investment guarantees. Banks are now the most important bulk fundraising source for local governments since shadow banking, financing vehicles and other off-budget debt raising channels have been blocked or are heavily restricted. Fraser Howie, co-author of Red Capitalism: The Fragile Financial Foundations of China’s Extraordinary Rise, said this development is “nothing surprising” and a sign “how little progress has been made in making these institutions commercial”. “So once again here we have the big five banks bailing [local governments] out,” he said. “The so-called commercial banks are once again an arm of fiscal policy and are being used as a form of stimulus.” But at the business level, such cooperation between the big banks and local governments is viewed as a win-win situation. “Banks need to find good clients after the central bank’s monetary loosening, while local government-led projects, including subways, intercity railways and other financing vehicle projects, are still better destinations [for profitable lending] than small businesses,” said Iris Pang, chief Greater China economist at ING Bank. In addition, local officials continue to believe that they will earn advancement with the Communist Party hierarchy if they produce strong short-term growth, regardless of the long-term consequences. “The competition for higher-ranking jobs and the obsession with investment-driven growth lingers [among officials] at local levels, despite the central government’s statement that it is downplaying [gross domestic product] growth” as a criteria for political advancement, Pang said.