Is local government debt a serious threat to the Chinese state?

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Shuguang Jiang's picture

Is local municipal government debt a serious threat to the Chinese state? My straight answer is no. It will not threat the local states but the whole country. Though different provinces or municipalities have their diversity, they share the common economic model which is dominant by the state owed sectors and the local governments all seek the same political and economic target. Creditors do not concern about weather local government becomes insolvent. They believe the central government will never let it happen. Since the major creditors are banks which are under government control, when a local government faces debt defaults, the solution is usually borrowing new debts to repay old ones. So, a single local government is hard to go bankrupt, but push the problem to accumulate and finally threat the whole country.

As is illustrated in Figure 1, since 1997, the size of China’s governmental debts has unfolded an annual growth. The debts grow rate was much higher than that of GDP, following a rapid revenue growth rate. The percent of government consumption expenditures in final consumer expenditures has grown slightly year by year with the government scale is expanding. While on the other hand, household consumption expenditure growth rate has been lower than GDP’s for most of the years. Government put most of capitals into infrastructure and fixed asset investment.

 

 

Figure1. Growth rate of major index from 1997 to 2010

(Note: The growth rate from 1998 to 2002 is mean annual growth rate from 1998 to 2002, and the growth rate from 2003 to 2007 refers to the mean annual rate from 2002 to 2007. Data of debts growth rate comes from National Audit Office of China, other data comes from National Bureau of Statistics of China)

To handle the global financial crisis began in 2007, governmental debts in most countries have grown rapidly. Chinese central government pushed a 4 trillion project to stimulate the economy, while most of the money requires local government to afford. Since the local governmental revenue is quite limited, most local governments borrow debts through financing platform companies with the total number of 6576. The size of debts has grown significantly in the past four years and becomes a serious problem which attracts much attention. Though nobody knows the exact scale of the debts, according to National Audit Office of China’s overall auditing on the debts of China’s local governments (General Serial No. 104), by the end of 2010, the balances of the local governmental debt stood at 10.717491 trillion RMB. This is double the size of local governmental revenues in 2011. Bank loans constituted large part of the source of borrowing (79.01%). Most of the funds (more than 70%) were used in municipal construction, communication and transport, land collection and preservation, public facilities and infrastructures.

As of the end of 2010, Chinese government’s total debts achieved 17.83833 trillion RMB, this is around 44.8 percent of GDP. Though there is no simple answer how much debt is sustainable, following Abdul Abiad and Jonathan Ostry’s (2005) median level of 30 percent of GDP, China’s debt level is a little high, but lower than most of European countries. The deficits accounted for only 1.7 percent GDP in 2010, lower than the indicator level of 3 point in European countries. At the end of 2010, the ratio of repayment from 2011 to 2015 are 24.49%, 17.17%, 11.37%, 9.28% and 7.48% respectively. The burden of repayment in future years will mitigate. The default risk does exist, but local government usually will choose repaying old debts by raising new ones. The risk will accumulate instead of breaking out with single local government going bankrupt. The risk will assimilated by the whole economy and may become a serious threat in the future.

The fundamental reason for this situation is that China is quite different from other countries, the government is so powerful while its power is unrestricted. They do not need constitutional arrangements for taxation and debt borrowing, and the lender banks’ activities actually under the government control. So the government has the incentives to make the snowball growing bigger and bigger, and transfer the burden to private sectors and the general public. Since much of the funds was put into infrastructure and other fixed assets, most of them are weakly managed and function with low efficiency. This phenomenon is named “GDP economy” in China,  which means the ultimate goal is GDP growth rate rather than people’s welfare. Some money was used to push down a building and then build another one. Those who have tight relationship with government benefit from this system, while most of people can not. Millions of people with creative talent make great efforts to be a part of the interest group instead of doing productive jobs. As this game move on, the private sectors in China are seriously restrained, which are the ones having high efficiency and directly benefit people’s lives.

The conclusion is clear, the local municipal government debt will not threat a single state (province or city), and it is just the tip of the iceberg of China’s political problem. At present the debts scale is big and with 10% overdue debts, but the government will repay old debts by raising new ones and raising taxes rather than reduce budgets and decrease investment. The government scale is expending without ultimate check. This is a serious threat to the national economy and politics. Political reform is the basic measure of dealing with the debts problem, and the governmental power and activities should be restricted in finite areas, leaving more space for private sectors.

References: 
  1. Abiad, Abdul and Jonathan D. Ostry, 2005 “Primary Surpluses and Sustainable Debt Levels in Emerging Market Countries”, IMF Policy Discussion Paper, PDP/05/6.
  2. National Audit Office of China, 2011, “Audit Findings on China’s Local Governmental Debts” No.35 of 2011 (General Serial No. 104).