There are growing signs that debt repayment pressure on China’s local governments will make it difficult for them to boost economic growth.

According to a Bloomberg report, the total outstanding bonds of 31 provincial governments in China are close to the risk threshold set by the Ministry of Finance. Crossing this line means local governments face more regulations on their loans, which will impede economic growth. The regime also warned that the provincial debt ratio accounts for 120% of their income.

Meanwhile, China’s nearly $2.1 trillion in municipal bonds, and more than 40% of the country’s outstanding loans, will mature within the next five years. Amid slowing income growth, debt repayment pressure across China’s provinces will continue to mount.

Bloomberg pointed out that although the default risk of provincial governments is not high, they will become increasingly difficult to repay. In the future, many will have to issue more and more bonds to repay maturing debt instead of financing new spending.

A major cause of the financial crisis was the housing crisis. Local government revenue mostly comes from land sales, that is “land transfer fees.” They accounted for more than 30% of local government revenue in 2020. But that income has plummeted amid a housing slump.

According to the National Institute of Finance and Development, a Beijing-based consulting organization, real estate transfer fees fell sharply in the third quarter, with only Gansu province in the northwest reporting growth among 31 provincial-level administrative regions.

In addition, the economic downturn caused by the “zero-COVID” policy also reduced tax revenue, and local governments also have to deal with trillions of yuan in tax exemptions due to the economic recession of the past few years.

Recently, the CCP’s Central Committee acknowledged for the first time their concerns about the repayment risks of special local debts and urged the Shenzhen Science and Technology Center to develop a government debt service reserve fund system to control debt settlement risk. In fact, Shenzhen’s financial situation is much better than other regions, so it is considered a test area for financial reform.

According to an October announcement on the website of the CCP’s National People’s Congress, some delegates warned that it was “very difficult to pay on time” local government debts that were due in the coming years. They called for contingency plans to be put in place as soon as possible.

Ding Shuang, an economist at Standard Chartered Bank, said the regime should take on more of the debt burden by borrowing more.

Ding Shuang told Bloomberg, “Regional finances have turned quite weak over the past few years.” He added, “The government will come under more and more pressure to make the change. It is a matter of time.”

If the regime issues more bonds to finance infrastructure projects, the state budget deficit will increase (currently at 3% of GDP). To keep the numbers on the books, the CCP has always given priority to provinces to issue more special bonds.

Ding estimated that if local special bonds are included, this year’s overall fiscal deficit will amount to 7.3% of GDP.

He said, “Such a high rate can’t last long.”

The CCP sets the risk threshold for each province’s debt at 120% of the province’s “financial inclusion.” The sources of financial inclusion are generally considered to be the total public budget, the revenues from the government Treasury budget, and the transfer payments from the central government. This ratio has increased as the regime ramped up fiscal stimulus during the pandemic.

Based on official data, Bloomberg estimated that provincial debt as a percentage of income rose from 83% in 2019 to 118% at the end of September.

According to a report by China’s Ministry of Finance, in order to keep overall loans below the allowable threshold, high-risk areas will have to limit the size of investment projects, cut public spending, and liquidate assets. 

Next year will be a particularly difficult year for Chinese local government finances, Bloomberg said. About 3.65 trillion yuan (about $510 billion) of bonds will mature by that time, reaching the current record high.

Even interest expenses have gotten worse. In the first nine months of this year, interest on special bonds amounted to 479 billion yuan (about $67 billion), accounting for 6.2% of government-managed fund budget spending. According to regulations issued in 2016, if this ratio exceeds 10%, a financial restructuring plan must be proposed.

In addition, local governments may have many hidden debts.

As previously reported by the South China Morning Post, local authorities have begun aggressively acquiring land through the so-called local government financial vehicle (LGFV).

LGFV was established to support off-budget financing, especially infrastructure spending, but the level of transparency is very low, raising concerns about potential debt risks.

Some local governments are causing a liquidity crisis due to falling incomes and desperately increasing land purchases, analysts told the South China Morning Post.

According to data from China Real Estate Information Corporation (CRIC), in the first nine months of 2022, LGFV’s land purchases among the top 100 land buyers in China increased sharply, reaching more than $28 billion, while the total land spending of the top 100 property buyers in the same period fell 51%.

Standard & Poor’s analyst Laura Li pointed out, “We believe LGFV’s land purchase could put a strain on their cash flow and increase leverage, especially on vacant lots that are unlikely to acquire capital. Many home purchases take place in lower level cities or areas with falling property markets, which increases the risk.”

According to Standard & Poor’s data, in Wuxi City, Jiangsu Province, LGFV won 65% of the 48 plots sold in the first nine months of 2022, accounting for a total of $4.2 billion.

Standard & Poor’s said an LGFV in Wuxi would use the equivalent of 39% of its total assets to purchase land.

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