Chines Municipal Debt: A Growing Issue

Published on Author fishman

At the upcoming Plenum, the CCP’s central committee will embark on a four-day gathering to focus on policy for the coming year. At the event, many analysts are expecting “local-government funding” to be one of the top three most likely areas of policy discussion, predicting that China will focus on reforming the issue over the next 12 months. In the public sector alone, the amount of leverage within the Chinese economy over the past few years has been skyrocketing. Standard Chartered Plc estimates that regional borrowing has expanded by approximately 24.4 trillion yuan ($4 trillion) since 2010. The rapid escalation in credit within the system clearly heightens systemic risk. Credit growth has contributed to the rapid appreciation of housing prices within China.Plenum

China’s current system for providing both welfare and municipal funding fosters real-estate related incentives. Public welfare is provided at a local level, yet, the central government does not provide sufficient funding to the provinces, leaving the regions with significant budget shortfalls and limited potential revenue generation sources. As a result, many municipalities will requisition land at a predetermined value and flip it for a profit. The re-sold land is bought by commercial developers, industrial firms, etc. for materially more than the government paid the initial landowner, arbitraging the system as home prices appreciate. Clearly, a precarious manner of funding, contingent upon rising home values. As Tom Miller explains it, “At the heart of the problem is China’s dysfunctional fiscal system…most local governments in China run a perennial budget deficit, because they are required to provide more services than they can afford…on average, one-quarter of local government revenue comes from land sales…” (91).

The result—often aggravated due to local-government corruption—is eminent domain. Many farmers are relocated from their property to housing complexes without land or proper compensation. Around 200,000 hectares of land are requisitioned in China from farmers every year, which some analysts believe catalyze approximately 60 percent of social unrest (83). Thus, the ability for municipalities to fund themselves through other means, besides arbitraging real-estate at the expense of the rural population, is going to be critical going forward. A levered public sector stimulating real-estate value appreciation is neither sustainable nor stable. Going forward, China should look to further property rights of its rural population and generate revenue for welfare benefits through real-estate taxes and the like.



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2 Responses to Chines Municipal Debt: A Growing Issue

  1. I think David makes an excellent point. Local governments are encouraging a property bubble. I know the unpopulated “ghost cities” are increasingly common. This form of financing by speculating on real estate is not sustainable. Hopefully the credit market doesn’t tighten/real estate prices fall prior to the implementation of a new financing strategy. Otherwise the outcome could be very painful for Chinese municipalities. With the inefficiencies in the tax system, I can’t imagine what would happen if local governments had to rely solely on tax revenues.

  2. Note in the Miller book that Chongqing had roughly $160 billion in debt at the time of writing, and its urbanization strategy would require another $100 billion in housing and infrastructure construction. Now this infrastructure is of value, the issue is how the revenue stream is structured. Lots of localities are waiting for the ability to impose real estate taxes….or to have the debt nationalized and handled by the central government which currently controls most tax revenues. It’s not clear which direction the government is heading.

    Separately, who holds the debt? If it’s ultimately the big state banks through loans to the many local real estate development corporations (controlled by local governments), then the central government can’t escape.