China’s New Tax Cuts Add to Local Governments’ Funding Woes

China will deliver 550 billion yuan ($84 billion) in tax cuts to help support the economy’s recovery, a move that could also damage local governments’ finances further.

The government will lower taxes for small and micro-sized businesses and offer tax breaks for companies in advanced manufacturing, state media reported Wednesday, citing a State Council meeting chaired by Premier Li Keqiang. That’s on top of record tax and fee cuts last year.

“It’s going to be a year where you could see increasing funding pressure for regional local governments,” particularly those already facing broader credit rating challenges, said Gene Fang, an associate managing director of sovereign risk at Moody’s Investors Service. “That will make the recovery from the pandemic more difficult.”

Regional public finances are already constrained and debts have surged, resulting in a wave of defaults by state-owned businesses last year. Local governments have become reliant on off-balance sheet financing to fund infrastructure projects, with this so-called hidden debt becoming a major worry for Beijing.

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Revenue growth will be “very constrained” and even flat this year, as much of the tax cut measures last year are also likely to be extended into 2021, Fang said. China reduced taxes and administrative fees by more than 2.6 trillion yuan last year, a record high, after cutting them by 2.36 trillion yuan in 2019.

China’s augmented fiscal deficit, which includes off-budget spending, climbed to 13.2% of gross domestic product in 2020 from 11.2% the year before, Natixis SA estimates. The deficit could remain high at 11.6% this year, it said in a report Thursday.

China’s New Tax Cuts Add to Local Governments’ Funding Woes

Moody’s expects new onshore bond issuance by local government financing vehicles, one of the primary components of regional hidden debt, to record single-digit growth this year, after surging by 28% last year to 4.4 trillion yuan, according to a note published Monday.

“Many lower-tier local governments are continuing with ambitious, debt-funded capital spending,” said Susan Chu, a credit analyst at S&P Global Ratings. “Local governments’ sustained deficit and large capital spending continue to exert heavy fiscal strains.”

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