Anna Wang and Matthias Stepan
China struggles to rein in the accumulation of public sector debt at the provincial and municipal level through new financing vehicles. The promotion of public-private partnerships (PPPs) will not solve the problem as long as many of the “private” partners in such infrastructure funding projects are state-owned enterprises.
The soaring debt load of local governments is a major threat to financial stability and economic growth in China. Between 2010 and 2013 alone, local debt increased by 67 percent to 17.9 trillion CNY (2.95 trillion USD) – an amount equivalent to 30 percent of Chinese GDP. And these numbers don’t even reflect debt accumulated outside official balance sheets.
The Chinese government is clearly alerted. According to an article in the party mouthpiece Global Times, the Ministry of Finance started investigations into the outstanding debt held by local government financing vehicles (LGFVs) and state-owned enterprises this October. The article is remarkable because it openly addresses a long-neglected problem - though its conclusion that local debt is in a “controllable range” is highly debatable. At least so far, attempts to mitigate the problem through smarter financing solutions seem to be failing.
Since the 1990s subnational governments have used so-called local government financing vehicles (LGFVs) to fund public infrastructure projects. LGFVs are registered as companies and function as investment agencies. Subnational governments provide them with capital by transferring tax revenue or land-use rights, and the platforms deposit these assets as collateral with state-owned banks. In return, subnational governments receive loans to finance public infrastructure projects.
Central efforts to limit local debt accumulation
In 2014, the central government attempted to limit local borrowing and rein in off-balance sheet debt accumulation. The revision of the Budget Law allowed local authorities to issue bonds, and it also introduced a debt-for-bond swap program.
At the same time, Beijing started promoting public-private partnerships (PPPs) as an alternative to LGFVs for infrastructure financing. However, there is evidence that provincial governments continue to turn to alternative funding methods and that the rising number of PPPs does little to counter the trend of surging local debt.
Even after the policy changes, the International Monetary Fund (IMF) estimates that local government debt increased to 28.2 trillion CNY (4.2 trillion USD), equal to 41 percent of GDP, by the end of 2015. Taking a closer look at off-balance sheet debt reveals an even gloomier picture. Net bond issuance by LGFVs reached a high of 1.2 trillion CNY (180 billion USD) by late September, significantly more than the total 946 billion CNY issued in 2015.
In 2015, the National Development and Reform Commission (NDRC) published a list of 2,309 demonstration projects, which were financed through PPPs. Projects in this PPP database include the expansion of regional airports, such as Ertaizi airport in Jilin province, or the upgrading of provincial railroad networks. In August 2016, the Ministry of Finance announced that it aims to fund 9,285 infrastructure and public service projects worth 10.6 trillion CNY (1.6 trillion USD) through PPPs.
Many PPPs are just another way of off-budget financing
The use of PPPs to prevent a further mushrooming of LGFVs appears reasonable. Yet in practice it might exacerbate local debt problems since the “private” component of a public-private partnership in China is not as private as it may sound. In an environment where local authorities prefer to work with state-owned enterprises (SOEs), many PPPs appear to be nothing more than camouflaged off-budget financing.
Given the massive debt burden, the lack of appropriate risk assessments, and the absence of truly private partners, the recent promotion of PPPs may prove to be more of a curse than a blessing for the fiscal health of many Chinese provincial level governments. Our data (see table below) indicates that a number of underdeveloped provinces with the highest debt-to-GDP ratios lean most heavily on PPP projects. Furthermore, PPP investment volumes in more vulnerable provinces tend to represent a larger percentage of the respective provincial annual budget.
Promoting PPPs without tightening their regulation will not wean local governments of their dependence on alternative financing. At the same time, PPPs aggravate the economic problems of inefficient SOEs that partner with subnational governments to fund unprofitable infrastructure projects. Failure to address the underlying structural problems intensifies local debt woes and reduces incentives for fiscal reform. In the worst-case scenario, the Ministry of Finance will end up having to bail out local governments – with unpredictable consequences to the financial system and the economy as a whole.
Anna Wang is a recent Master graduate of the Diplomatic Academy of Vienna, where she majored in Economics and Political Science. She earned her bachelor’s degree at the Bates College in Lewiston, U.S.A. From August to November 2016, she worked as an intern in the research area politics, society, and media at MERICS.