China’s debt risks on the rise as Beijing vows ‘appropriate spending intensity’ to bolster economy

World’s second-largest economy intends to expand the areas where special purpose bonds are invested this year, finance minister says
And central government will not cut back on spending to support people’s livelihoods and continue fighting against the coronavirus

China's economic recovery

Amanda Lee

Published: 8:00am, 5 Jan 2023

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Beijing is warning of the need to minimise and contain debt risks as the country embraces a more expansionary fiscal policy – including widening the use of bond proceeds – to shore up the nation’s post-Covid economic recovery this year, according to a senior official.

China’s policymakers have vowed to strengthen policy adjustments to cushion the impact on businesses and consumers of a widespread surge in coronavirus infections after Beijing abruptly abandoned its zero-Covid policy a month ago.

The world’s second-largest economy is also facing slower export growth and a property market downturn, while dwindling local government revenue has raised concerns about the recovery of regional economies and mounting debt risks.

Finance Minister Liu Kun said in an interview with Xinhua, published on Tuesday, that the government needs to expand fiscal spending at an “appropriate” rate, while also “appropriately” expanding the areas where special purpose bond funds are invested. And he pointed to the importance of supporting poorer and less-developed parts of the country by increasing payments from the central government.

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In 2022, the country’s total tax refunds, tax and fee cuts, and tax deferrals for Chinese businesses exceeded 4 trillion yuan (US$579 billion), Liu said, adding that these measures may be extended or optimised in 2023 as needed.

Liu also vowed that the central government would not cut back on spending to support people’s livelihoods this year, and that it would maintain “appropriate spending intensity”, including the allocation of more funds to support education and continue fighting against the coronavirus.

Special purpose bonds, which are commonly used by local governments to fund infrastructure spending, remain important in driving the expansion of “effective investment” and in “stabilising the macro economy”, Liu said.

Since 2018, China has approved the sale of 14.6 trillion yuan worth of new local government special bonds to support the economy, Liu said. That includes about 4 trillion yuan worth of such bonds that were used to support the construction of nearly 30,000 projects from January to November of last year.

China’s fiscal deficit target for 2022 was set at around 2.8 per cent of gross domestic product (GDP). The new target for this year, and the new debt quota, will be announced at the annual parliamentary meetings this spring.

China’s outstanding government debt is below 60 per cent of GDP so far – lower than the global general debt-to-GDP ratio, Liu said.

Liu also vowed that departments at the finance ministry would strengthen their supervision and management of local government debt and “firmly guard the bottom line in preventing systemic risks”.

“[We will] promote the market-oriented transformation of financing platform companies … and promote sustainable financial development,” Liu added.

Will there be more defaults in local government financing vehicles when the economy continues to decline and the corresponding debt leverage further deteriorates?

Liu Yuanchun

Given the need for more spending to support the economy, fears have been mounting over the rising local government debt risks and the potential impact on the state-dominated banking sector.

Liu Yuanchun, president of the Shanghai University of Finance and Economics, said last week that a prolonged property-market crisis, more defaults of local government debt and volatility in financial markets were among the key risks facing the economy this year.

“Will there be more defaults in local government financing vehicles (LGFVs) when the economy continues to decline and the corresponding debt leverage further deteriorates,” Liu posited on Friday at the Ifeng Finance Summit.

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On Friday, the Zunyi Road and Bridge Construction Group, a state-owned contractor in the southern province of Guizhou that issues debt to fund local infrastructure projects backed by the local government in repayment, said creditor banks had agreed to a 20-year rollover of loans worth 15.6 billion yuan. The builder has already defaulted on some of its debt in the past and faces rising pressure to repay loans.

It came after the approval by the State Council in January 2022 for Guizhou, one of the most indebted provinces in the country, to allow government-owned borrowers to negotiate with banks to extend debt repayments – part of a programme to restructure debt and mitigate debt-default risks.

To control debt risks, Beijing has already banned new set-ups of LGFVs and local governments from directly offering credit guarantees to LGFV debt, while also demanding better disclosures of the use of funds.