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China Fiscal Aid Little Comfort for Cash-Strapped Provinces

China’s Fiscal Aid Is Little Comfort for Cash-Strapped Provinces

Local officials from across China are in Beijing this week for the annual full-session of the country’s parliament with a common plea for President Xi Jinping’s government: we need more money.

One of them was Zhu Shixi, the local party chief for the city of Nanyang in the central Henan province, which is having to invest tens of billions of yuan on a project to divert water to Northern China. Decades in the making, the development is one of the biggest of its kind in the world, and was showcased by Xi himself in a recent visit to Nanyang last year.

The “local government’s finances are overwhelmed by the heavy load” of spending required, Zhu said in a proposal submitted to the National People’s Congress, according to a report in The Paper. At the same time, the city’s fiscal income is shrinking by more than 2 billion yuan ($317 million) a year, he said. He proposed Beijing give his city more of the money collected from water taxes.  

China Fiscal Aid Little Comfort for Cash-Strapped Provinces

Slowing economic growth and the weakest property market in half-a-decade are sapping the flow of cash into local coffers just as cities and provinces face a record $440 billion of bond payments coming due this year. For most local governments, the only way to bridge the gap between what comes in and what goes out is with more borrowing and more money from Beijing.

“The difficulties faced by local governments are unprecedented this year,” said Xing Zhaopeng, senior China strategist at Australia and New Zealand Banking Group. Without more money from the central government, “less developed regions may even have problems paying salaries to government employees and public school teachers,” he said before the NPC.

China Fiscal Aid Little Comfort for Cash-Strapped Provinces

There were signs in the budget released over the weekend that the central government was responding to the pleas from the regions. Premier Li Keqiang said a record 9.8 trillion yuan would be transferred to local governments this year, up 18% from 2021. Transfer payments will be the equivalent of 85% of the income provinces will generate on their own this year, according to Bloomberg calculations based on official data. 

The promised boost may not be as big a help as it first appears though. Li also announced plans for nationwide tax relief this year of around 2.5 trillion yuan, more than double the size of last year. Much of that money will come from local budgets, which are already stretched. 

In another sign that China’s trying to pull together all the resources it has to support the economy and local government finances, the People’s Bank of China said in a statement late Tuesday that it will send more than 1 trillion yuan in profits to the finance ministry to help pay for tax rebates. Some of the money will be transfered to the provinces, the central bank added. 

Competing Goals

In March 2019, before the pandemic ravaged lives and public finances in China and the world, local officials were already raising fiscal concerns at the annual parliament meeting. Three years later, many of the provinces and cities across the nation are in an even worse financial position.

Local authorities are caught between competing demands to spend more on everything from industrial subsidies to education to an expensive and ongoing campaign to contain Covid-19, and paying down debt, especially ‘hidden’ or off-balance sheet borrowing. And they are forced to do that with weaker revenues as economic growth slows and a housing slump undermines revenue from land sales.

China Fiscal Aid Little Comfort for Cash-Strapped Provinces

An example of these problems comes from Chongli county near Beijing, which recently hosted many of the events at the Winter Olympics. The local authority racked up debt to pay for the ski slopes and other sports facilities, but revenue didn’t keep up with the spending and higher levels of government are yet to step in to help, the Financial Times reported in January. 

The origins of this problem lies in the early 1990s, when Beijing forced the provinces to cede control of many taxes to repair the central government’s budget. Double-digit annual growth after that meant central government revenue boomed, but so did demands for local governments to spend more on education and social welfare, creating a budget gap which was partly filled by borrowing money on the sly via special off-balance sheet companies or selling off land. 

Land Revenue

Land is a significant resource for China’s cash-strapped local authorities, with the revenue from sales tripling over the past 10 years as the government sold long-term rights to use state land to developers for homes, industrial parks, and shopping centers. However, the slump in home sales, which started in the second half of 2021 has undermined that demand, with developers pulling back on spending for the future to try and survive the current crisis.

China Fiscal Aid Little Comfort for Cash-Strapped Provinces

Some governments are now even effectively selling land to themselves to boost their finances. For the first time since 2010, the annual budget released last week didn’t include a revenue target for land sales, a recognition of the uncertainty plaguing real-estate markets. 

Debt Stress

Local authorities have also been stepping up their borrowings via bonds, especially to finance infrastructure investment. By the end of 2020, outstanding local government bonds equaled 94% of total income, Deputy Finance Minister Xu Hongcai said in December. That was just under the 100% level China has officially set as a risk alarm line. 

In fact, the stock of official debt is estimated to have surpassed 100% of local government adjusted total revenue in 22 provinces last year, according to a S&P Global Ratings report last week. The burden was heaviest in the northern port city of Tianjin at more than double income, followed by Guizhou in southwest China and Inner Mongolia in the north.

“The debt stock of local governments has reached record high levels following the 2020 stimulus to fight the pandemic,” said Susan Chu, senior director at S&P Global Ratings. “It’s getting close to the implicit threshold for the central government to slap controls.”

Repayment pressures are also growing, with regional authorities spending almost 1 trillion yuan paying interest last year and another 2.7 trillion yuan repaying bond principal, more than 15 times the amount in 2015. More challenges lie ahead, with 9.4 trillion yuan of bonds maturing over the next three years, according to Bloomberg-compiled data.

Most Chinese municipal-level governments already run a fiscal deficit, China Merchants Securities Co. analysts including Zhang Yiping wrote in a January note, citing their survey of 293 cities. And the situation may be getting worse, with the first municipal-level fiscal restructuring reported in December.

Possible Solution 

The national government has been talking about creating new sources of stable, long-term income for local governments to alleviate these problems, but there’s been little progress. 

A nationwide tax on real estate ownership has been talked about for over a decade as one solution, and in October last year parliament authorized the trial program in Shanghai and Chongqing be expanded to more cities. However, that news was negative for already weak home sales and the plan has been delayed until the market is stronger. 

For now, provincial budgets will likely remain under strain. With the government’s focus this year squarely on boosting fiscal stimulus to support growth, it’s unlikely that any new taxes or revenue sources will be introduced to help repair local finances.

©2022 Bloomberg L.P.

With assistance from Bloomberg