Nearly half a century later, that position remains etched in the hearts of Beijing’s finance ministry bureaucrats.
- China’s central government debt has crept to about 24 percent of GDP, a low level by global standards, and the leadership is extremely reluctant to let it rise much higher.
- By contrast, China’s local government debt is massive—93 percent of GDP, according to IMF figures, which are probably an underestimate—and rising.
- This division between central and local governments, and the desire of one to control but not take responsibility for the other, is a key element in the economic challenges facing China today.
In an article in the Financial Times, writer Robin Harding, in which he talked about the key challenges facing the economy, regarding the debt problem, said that the basic fact in China’s financial system is that local governments handle almost all spending, but depend on the center to collect revenues to an extent rare anywhere else in the world.
Localities bear most responsibility for education, health, social security, and housing, as well as obvious local duties such as roads, parks, and garbage collection, and spend about 85 percent of total government revenue. They collect only about 55 percent of government revenue directly. This system is balanced by transfers from the center to the regions.
“In a large country like China, there are advantages to delegating decisions to the people, but the mismatch between revenues and expenditures creates many problems,” he added. “For example, the lower the level of government, the more the system becomes starved of resources, because each level—provincial and county—tends to withhold what it needs before passing the money down the chain. The implementation of central government spending plans is haphazard. Meanwhile, local government officials, who must grow in order to rise through the bureaucratic ranks, do everything they can to find money,” the author wrote.
Real Estate Sector
He said China’s property boom was driven in part by local governments’ reliance on land sales to generate revenue. Off-the-book borrowing through so-called local government financing mechanisms was a way to circumvent revenue constraints and finance infrastructure.
With land sales falling due to a slowing housing market and the central government cracking down on local borrowing, there are reports of municipalities resorting to fines and penalties, launching retroactive tax investigations or simply not paying employees on time as they struggle to balance their books. None of this is good news for the struggling private sector.
Beijing knows all about these structural problems, and has long wanted to fix them. Indeed, financial reform was a big part of his domestic policy agenda when Xi first took power in 2012, and he has succeeded in implementing some elements of it.
Government suffering
One reason local governments are struggling, for example, is that successful reforms in budget and financial management have made it harder to cover up problems by keeping them off the books.
- What the central government was not willing to do, as is usually the case with Xi, was to cede control, the article said.
- The government often determines the services that local governments must provide, but refuses to hand over the revenue sources that fund them.
- The government is reluctant to take on major new spending responsibilities on the central books.
- The government has cracked down on local government debt, however, in keeping with Zhou’s preferences, it is unwilling to allow central government debt to rise instead.
- The result has been de facto fiscal tightening over the past few years even as the economy struggles to recover post-Covid.
At the recent Third Plenum, a key economic policy meeting held once every five years, Beijing promised to change that. It said it would give local governments more control over taxes and increase fiscal transfers from the center. It would consider consolidating various local fees into a single local tax. It would shift responsibility for the consumption tax from manufacturers to retailers and let local governments collect it, a major reform. And where the central government has greater fiscal power, it would increase “the proportion of central government spending accordingly.”
But China has set a similar tone in the past, notably during the protracted debate over whether to introduce property taxes, the natural way local governments finance local spending.
If Beijing is to actually implement these plans, it will have to cede some control, and if it is to do so while reviving the stagnant economy, it will also have to accept rising central government debt, the article’s author said.
How does the Chinese economy work?
For his part, the writer specializing in Chinese affairs, Hussein Ismail, said in exclusive statements to the “Sky News Arabia Economy” website that to understand the nature of the Chinese economy, we must understand the nature of its work, as it consists of a central government with a budget and local governments with another budget, and the imbalance basically comes from the increase in the debts of local governments compared to the central government.
“The Central Committee of the Communist Party of China, which met last month, addressed this issue and took measures to limit the ability of local governments to obtain loans from banks or any other party to reduce the debt crisis,” Ismail added.
The researcher in Chinese affairs confirmed that this step will greatly affect the Chinese economy; local governments, with their ability to obtain financing restricted, will affect the implementation of some projects in Chinese provinces. However, for the national economy as a whole, the issue of debts will not greatly affect the performance of the economy, noting at the same time that the International Monetary Fund expects the Chinese economy to grow by 5 percent during the current year 2024.
Ismail stressed that there are four factors that greatly affect the Chinese economy currently, which are:
- The performance of many global economies is weak, given that the Chinese economy relies heavily on exports to them.
- Global supply chain issues.
- Restrictions imposed by the United States and some European countries on Chinese exports, especially electric cars.
- Some imbalances in the Chinese economy and the problem of real estate and the debts accumulated by real estate development companies in China.
Ismail stressed that to solve these problems, China resorted to solutions that included:
- Expanding the domestic market by increasing domestic consumption. China has 1.4 billion people and this is a very large market for consuming the export surplus.
- China has adopted a package of policies to encourage and stimulate domestic consumption to compensate for the decline in exports.
Challenges
In this context, Dr. Walid Gaballah, a member of the Egyptian Society for Economics and Legislation, stated during his interview with the “Sky News Arabia Economy” website that China’s debts are considered one of the major challenges facing the Chinese state, but they are not the only ones, as the debt crisis is worsening in all countries of the world.
He added: “The United States of America, for example, is the largest country suffering from a debt crisis, as the US debt ceiling has reached 34 trillion dollars, and thus the Chinese debt crisis (related to local governments) is part of a global crisis.”
Jaballah continued that China dealt with this crisis with proactive measures to control it:
- When the real estate debt problem broke out, China put restrictions and red lines on real estate financing, and this is what happened in the technology sector as well.
- The Chinese state has succeeded in containing the problem in general, so that it does not turn into a sovereign crisis, and has succeeded in making it fall within the framework of companies only.
- Local government debts are also a burden, but there are mechanisms used by the government, such as stimulating the economy and targeting a growth rate of perhaps more than 4 percent, which will result in absorbing the debt challenges to a large extent.
He continued: “China, like the rest of the world, is betting on time, geopolitical conflicts, and also on the US Federal Reserve not continuing to maintain high interest rates forever, and that sooner or later it will move towards an interest rate that reduces financing costs. Accordingly, it is working through well-thought-out plans to deal with these challenges and absorb them as much as possible until global economic indicators improve,” stressing that the Chinese economy is still capable of dealing with challenges, most notably the debt challenge.
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