Commentary on Political Economy

Monday 6 March 2023

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China’s Cities Struggle Under Trillions of Dollars of Debt

Financial obligations built up during pandemic weigh on growth as China’s legislature meets to address economic needs

The city of Zhengzhou in China has seen its fiscal revenue drop and total debt grow in recent years.PHOTO: YOKO KUBOTA/THE WALL STREET JOURNAL
By Stella Yifan Xie
, Yoko Kubota
 and Cao Li

As China tries to turn the page on one of its worst stretches of growth since the 1970s, its economy is being weighed down by the colossal debts of its local governments, which swelled during the pandemic and are starting to come to a head.  

Xi Jinping’s zero-Covid campaign saddled cities with billions of dollars in unplanned expenditures for mass testing and lockdowns. The Chinese leader’s crackdown on excessive property-market leverage led to a sharp drop in land sales, depriving cities of one of their biggest revenue sources.

WHAT'S NEWS

Two-thirds of local governments are now in danger of breaching unofficial debt thresholds set by Beijing to signify severe funding stress, with their outstanding debt exceeding 120% of income last year, S&P Global calculations show.

About a third of China’s major cities are struggling to pay just the interest on debt they owe, according to a survey by Rhodium Group, a New York-based research firm. In one extreme case, in Lanzhou, the capital city of Gansu province, interest payments were the equivalent of 74% of fiscal revenue in 2021.

China’s Cities Struggle Under Trillions of Dollars of Debt

Financial obligations built up during pandemic weigh on growth as China’s legislature meets to address economic needs

The city of Zhengzhou in China has seen its fiscal revenue drop and total debt grow in recent years.PHOTO: YOKO KUBOTA/THE WALL STREET JOURNAL
By Stella Yifan Xie
, Yoko Kubota
 and Cao Li

As China tries to turn the page on one of its worst stretches of growth since the 1970s, its economy is being weighed down by the colossal debts of its local governments, which swelled during the pandemic and are starting to come to a head.  

Xi Jinping’s zero-Covid campaign saddled cities with billions of dollars in unplanned expenditures for mass testing and lockdowns. The Chinese leader’s crackdown on excessive property-market leverage led to a sharp drop in land sales, depriving cities of one of their biggest revenue sources.

WHAT'S NEWS

Two-thirds of local governments are now in danger of breaching unofficial debt thresholds set by Beijing to signify severe funding stress, with their outstanding debt exceeding 120% of income last year, S&P Global calculations show.

About a third of China’s major cities are struggling to pay just the interest on debt they owe, according to a survey by Rhodium Group, a New York-based research firm. In one extreme case, in Lanzhou, the capital city of Gansu province, interest payments were the equivalent of 74% of fiscal revenue in 2021.

Chunks of debt are coming due soon. Research by Lianhe Ratings Global, a subsidiary of a large domestic rating agency, found that about 84% of the $84.2 billion in offshore debt owed by local government financing vehicles will mature between this year and 2025. 

The main concern isn’t that cities will default and trigger a financial crisis, though economists say that can’t be ruled out. It is that cities will have to keep cutting spending, delay investments or take other actions to keep creditors at bay, impairing growth for years.

In Zhengzhou, home to a Foxconn Technology Group assembly site for Apple Inc.’s iPhones, bus drivers say their salaries were cut in 2021 and haven’t been restored. Street sweepers report to work even though some say they haven’t been paid in months.

“Our salary isn’t high. Why does the country even owe us this kind of money?” said Xu Aiqiang, 67, as she swept a park on the west side of Zhengzhou. She said her company, a city contractor, hasn’t paid her monthly salary of around $320 for seven months. “Even if they aren’t paying me, I’m still keeping my areas clean, so I can see it for myself.”

Zhengzhou’s finances have been hit hard by China’s real-estate slump, leaving it with unfinished projects such as the ‘City of Joy.’PHOTO: YOKO KUBOTA/THE WALL STREET JOURNAL

Teachers in the southern megacity of Shenzhen are complaining on social media about sharp cuts in bonuses, an important pay component. In January, a heating company in the rust belt city of Hegang in northeastern China told residents to prepare for a cutoff in heat after the company failed to get subsidies from the local government.

Protests have broken out in recent weeks in cities such as Wuhan, Dalian and Guangzhou over public healthcare system overhauls that have included cuts in medical benefits due in part to strained government finances.

On Sunday, at annual meetings of China’s legislature in Beijing, Chinese policy makers offered only modest support for local governments, signaling they want to promote fiscal discipline. 

Fiscal transfers from central authorities to local governments, which Beijing provides annually, are set to increase 3.6% to around $1.5 trillion this year, a far cry from last year’s 18% increase. Municipalities will be allowed to issue around $550 billion worth of local government special-purpose bonds this year, down from last year’s actual issuance of $580 billion.

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A few days earlier, Chinese Finance Minister Liu Kun played down financial strains faced by local officials, saying on Wednesday that the situation remained mostly stable last year and is expected to further improve this year as the economy recovers.

The State Council Information Office, which handles press inquiries for China’s government, didn’t respond to a request for comment.

Economists note that Beijing still has plenty of fiscal room to intervene in individual cases if necessary to prevent major defaults. Local governments can also sell off assets, if they can find buyers.

However, the central government’s balance sheet isn’t strong enough to bail out every contingent liability in China, wrote Nicholas Borst, director of China research at Seafarer Capital Partners, a San Francisco-based investment firm, in a research paper on local debt released this month.

“Moreover, a one-off series of bailouts would increase moral hazards and not change the underlying dynamics that led to the problem in the first place,” he wrote.  

That means local residents—especially civil servants—may see more salary cuts and reduced services, as well as fewer infrastructure investments to power growth and employment.  

Property buyers waiting for their projects to be completed gathered near a provincial government building in Zhengzhou.PHOTO: YOKO KUBOTA/THE WALL STREET JOURNAL

“The real cost of the debt won’t be a financial crisis but it’ll lead to many years of struggling to allocate the cost of that debt,” said Michael Pettis, a finance professor at Peking University. 

Officially, China’s 31 provincial governments owe around $5.1 trillion, including bonds held by local and foreign investors.

Those figures don’t include a variety of off-balance-sheet debts typically raised through so-called local government financing vehicles, which have proliferated in recent years to fund infrastructure and other spending obligations. The debts from those vehicles are expected to reach nearly $10 trillion this year, according to the International Monetary Fund. 

The debt from those vehicles is more than the combined government debt of Germany, France and Italy as of the third quarter of 2022, according to European Union data.  

Interest on the debts crowds out other spending. The Rhodium Group research found that interest costs accounted for at least a fifth of fiscal resources in 25 Chinese cities in 2021. Anything over 10%—the case in more than 100 cities—leads to “meaningful constraints,” Rhodium said.     

Local governments’ debt problems have been building since the global financial crisis. Many became addicted to launching projects—which juiced growth—and selling land and borrowing more to pay for all of it, economists say. 

In addition, China’s local governments must shoulder most of the costs of services such as public education and healthcare. Beijing restricts how they can raise money, compelling them to send most of what they collect in taxes to the central government, while limiting what they can borrow. 

Zhengzhou, with nearly 13 million residents, has healthier finances than many other cities. Its streets are vibrant, with residents crowding eateries.

Yet in the past three years, Zhengzhou’s fiscal revenue dropped by 14% on average each year while total debt grew by 14% annually. Its debt-to-fiscal income ratio rose to 178% in 2022, from 75% in 2019. 

Some analysts say Beijing is unwilling to make changes that could put local government finances on a more stable footing, such as implementing a property tax to raise more funds, because doing so would be politically unpopular and could undermine central authorities’ control over localities.  

Selling more state assets risks going against Mr. Xi’s objective of using state players to achieve strategic goals such as self-sufficiency in key technologies.

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