China Moves to Reduce Local Debt... "Temporary Measures Cannot Solve the Problem"

Korea Institute for International Economic Policy ‘World Economic Focus’

An analysis has emerged suggesting that China needs to increase the central government's expenditure burden to reduce debt risks. It also included a forecast that maintaining the current fiscal allocation method will make it difficult to resolve the debt problem.

Last year's regional gross domestic product and debt ratio by region in China. Photo by Korea Institute for International Economic Policy

The Korea Institute for International Economic Policy (KIEP) released the 'World Economic Focus' on the 16th, pointing out that "to fundamentally resolve (China's debt problem), improvements are needed such as adjusting the tax allocation ratio between the central and local governments and expanding the central government's expenditure burden." Regarding the current fiscal redistribution structure between the central and local governments, it analyzed that "it may be difficult to fundamentally resolve local government risks."

Currently, China's local governments are suffering from chronic deficits while responding to COVID-19 and economic slowdown. This year, the scale of local bonds is estimated at 40 trillion yuan. This is equivalent to 32% of the Gross Domestic Product (GDP), larger than national bonds (23%). In particular, the debt of Local Government Financing Vehicles (LGFVs), which is not recorded on the books and is called hidden debt, is known to reach 66 trillion yuan this year (53% of GDP).

As the size of LGFVs increases, concerns about defaults have also grown. LGFV bonds maturing from this year through the first half of next year are expected to reach a record high of 5.54 trillion yuan. If defaults materialize, debt restructuring will be inevitable, and Standard & Poor's (S&P) has warned that regional banks could suffer capital hits of 2.2 trillion yuan during this process.

The Chinese central government emphasizes local governments' efforts to resolve issues independently while implementing countermeasures for risk management. The amount of money the central government sent to local governments increased from 8.2 trillion yuan in 2021 to 9.7 trillion yuan last year, and 10.6 trillion yuan this year. On the 24th of last month, the central government announced the issuance of 1 trillion yuan in special national bonds, with principal and interest guaranteed, to be used for local government disaster recovery and infrastructure projects.

Hidden debt is being converted into low-interest official debt called 'special refinancing bonds.' Since some bonds have maturities of up to 30 years, this can be interpreted as reducing default concerns. Accordingly, starting with Inner Mongolia on October 6, a total of 24 local governments issued special refinancing bonds worth 1.0435 trillion yuan.

However, KIEP judged that while these series of countermeasures are effective in the short term, they will be difficult to resolve in the medium to long term. This is because the risk of hidden debt has only been temporarily alleviated, and the total amount of debt has not decreased. Furthermore, in China's case, local governments receive only 50% of tax revenues but bear 80% of expenditures, so there remains a possibility of defaults occurring again over time.

This content was produced with the assistance of AI translation services.