Introduction
China is set to introduce a “basket of measures” to alleviate the risks posed by local government debt, which might encompass special bond issuance, debt swaps, loan rollovers, and reluctantly, a portion of the central budget. The impending municipal debt crisis has sounded alarms in Beijing, necessitating urgent action.
The Role of Local Governments
Local governments are essential to China’s economy, with provincial and city officials assigned to fulfill ambitious growth goals. Following years of over-investment in infrastructure and plummeting revenues from land sales, coupled with soaring COVID expenses, debt-laden municipalities have become a significant concern.
Recent Shift in Approach
China’s leaders last month pledged to assist in easing these debts, signaling concerns about potential defaults in municipal debt that could destabilize the financial sector. This message was seen as more constructive than previous demands for “strict control” over local debts, suggesting that Beijing has acknowledged the need to inject cash into the issue.
The change in attitude is considered a major breakthrough, given that Beijing has historically insisted that local administrations resolve their debt issues independently.
Central Government’s Role
The extent and conditions of central government involvement remain a matter of debate, with the duration and details of the measures still unknown. Investors are keen to understand the scope and permanence of Beijing’s solution.
According to Logan Wright, a partner at Rhodium Group, “The size of any restructuring and the scale of the problem Beijing acknowledges is important to the success of this effort.”
The Dilemma
Local government debt stood at 92 trillion yuan ($12.8 trillion), representing 76% of economic output in 2022, a sharp rise from 62.2% in 2019. The International Monetary Fund (IMF) expects debt issued by local government finance vehicles (LGFVs) to hit $9 trillion this year.
Beijing is caught between a rock and a hard place: offering no support could unravel the economic model with dire consequences, while intervention might promote reckless spending. An anonymous policy adviser emphasized that not all debt should be taken on by the central government to avoid moral hazard.
Options
Economists anticipate Beijing will direct state-owned banks to rollover maturing debt with longer-term loans at lower rates. Selectivity will be key, as restructurings could affect banks’ abilities to finance other sectors.
Local governments will also bear responsibilities, including coming clean on “hidden debt.” Analysts expect bond issuance quotas to be used to swap hidden debt with official bonds, a move that follows a precedent set from 2015 to 2018.
Beijing might also require certain localities to leverage assets to raise funds. Tao Wang, chief China economist at UBS, highlighted that “Extension of local government and LGFV debt and de facto restructuring, especially with banks, will likely be encouraged.”
The central government, having issued bonds in the past to address crises, might opt to issue low-cost bonds to replace local debt. Some experts believe such swaps should exceed 1 trillion yuan this year to be effective.
Additionally, more generous direct fiscal transfers for essential public services may be considered. The finance ministry expects a record 10 trillion yuan in transfers this year, an increase of 3.6% from 2022.
Reforms and Future Considerations
To prevent recurring local debt issues, policymakers must make profound changes to economic operations. Some analysts suggest reconsidering growth performance criteria for evaluating local government officials.
However, the ultimate decision may involve accepting lower growth after four decades of rapid expansion. Wright from Rhodium Group noted that “Whether Beijing will be able to accept a significant slowdown in local government investment, and therefore economic growth, will be one of the most important questions in any restructuring.”
Conclusion
China’s approach to resolving the local government debt crisis is of vital importance to both the domestic economy and global financial stability. By considering a multifaceted approach that includes bond issuance, debt swaps, and central government intervention, Beijing seems prepared to act decisively.
However, the details of this plan, its implementation, and its implications for economic growth remain complex and uncertain. It’s clear that the issue requires both immediate action and long-term strategic thinking, encapsulating the broader challenges and dilemmas faced by a nation seeking to balance growth, stability, and fiscal responsibility.
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