While Eurozone countries have been severely affected by the recession and some local governments are struggling with substantial debts¹, we may well ask whether another debt crisis could occur in China. Several newspapers have supported this hypothesis. Last August, Jonathan Kaiman, of Foreign Policy,warned of a potential debt bomb². Like Spain, China’s local governments have heavily invested in building new (extravagant) infrastructures. In many cases, however, these infrastructures have not fulfilled the cities’ needs, but rather reflected their visions of grandeur. Both in Europe and China, poor governance on the part of the urban authorities has been caused by shady financial deals. In China’s case, the systemic risks are limited, considering the country’s fiscal strengths, but this is, nevertheless, an issue that needs to be dealt with in the future.

In 2010, during China’s real estate bubble, Sarah Tong and Yao Jielu (East Asian Institute) wrote an interesting article describing the causes of China’s local government debts³.  According to the authors, Urban Development Investment Vehicles (UDIVs) were the main driving force behind local government debts. Because they were not allowed to issue bonds or directly borrows from banks, local governments set up municipal state-owned companies (UDIVs) in order to have access to bank loans. Thanks to the UDIVs, local governments could easily finance the necessary infrastructures for urban development. However, the authors point out several problems in local governments’ use of UDIV bank loans. They particularly blame the lack of transparency: the public do not have access to the projects’ objectives. UDIVs are poorly supervised and this leads to overlapping infrastructures. In addition, many UDIV loans depend on unreliable guarantees: local governments use land as collateral for loans, which can lead to defaults if there is a slowdown in real estate prices.

According to the authors, the central government partially succeeded in addressing this issue by recapitalising some banks, implementing new policies to restrict local government access to bank loans, and taking several measures to limit speculation.  However, these measures may not be sufficient. Two years after the publication of Tong and Yao’s article, the problem of Chinese local government debts is not fully resolved..  The central authorities first allowed local governments to issue bonds, but then restricted bond sales.  Local governments will not be allowed to sell bonds directly; the central government will sell them on their behalf⁴. This illustrates the central authorities’ fear that local government debts will increase.

To overcome the debt problem, China may still need to revise her tax policies. The limits of the 1994 tax reform are now apparent. Several simple tactics could be used:

• First, cities should not rely only on industry and land sales as their main financial resources. New tools should be found to rebalance urban development.
• Secondly, the central authorities should increase their control over local government projects. Independent agencies should be empowered to assess and check local government budgets and expenditures, so that public resources are used wisely.
• Local government expenditures should be reduced and redirected to the areas where they are most needed (such as education and low income housing). 

 China is not Europe. Beijing enjoys strong economic growth. The central government’s public debts, although substantial, are still under control; and unlike European countries, public debts are owned by national, government owned banks.

1. Zafra, I. (2012, December 20th)  La deuda valenciana se dispara a cotas históricas a pesar de la ola de recortes. El Pais. http://ccaa.elpais.com/ccaa/2012/12/24/valencia/1356365528_191495.html, accessed February 13th 2013 [↩]
2. Kaiman, J. (2012, August 13th) . China’s debt bomb. Foreign Policy. http://www.foreignpolicy.com/articles/2012/08/03/china_s_debt_bomb, accessed February 13th 2013 [↩]
3. Tong S. & Yao J. (2010). “China’s rising local government debts sparks concerns” East Asian policy, Volume 2, No. 4 http://www.eai.nus.edu.sg/Vol2No4_SarahTong&YaoJielu.pdf, accessed February 14th 2013 [↩]
4. Bloomberg News (2012, June 26th), China scraps trial of local government bonds, studies risks. http://www.bloomberg.com/news/2012-06-26/china-scraps-trial-of-local-government-bonds-studies-risks-1-.html, accessed February 13th 2013 [↩]

Sebastien Goulard

Ph.D. in political science (EHESS, Paris); M.A. in social sciences (EHESS, Paris); M.A. in international relations (IRIS, Paris), B.A. (Hons) in international political studies (ESE - Nottingham Trent University)

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