Written by Timna Michlmayr
Between October 30 and 31, the Central Financial Work Conference (Zhongyang Jinrong Gongzuo Huiyi), which is held every two years in China, convened in Beijing. At this gathering, officials engaged in discussions regarding the country’s financial objectives for the next five years.
The meeting has taken steps towards “financial development with Chinese characteristics” (Zhongguo Tese Jinrong Fazhan), in which Marxist financial theory plays a crucial role, and the Communist Party’s control over the financial sector is to be strengthened. Although the specific details of this concept remain somewhat unclear, the conference has established clear priorities for China’s financial system in the coming years.
The financial system is seen as the lifeblood of the national economy and an essential component of the country’s core competitiveness. Especially over the past year, China’s financial system has experienced instability due to a slow post-pandemic recovery, a local debt crisis, and challenges in the struggling property sector, all of which have undermined investor confidence. A central element of the conference was, therefore, the elimination of systemic financial risks through a more centralized financial oversight and the establishment of a robust financial sector. Part of the planned reform measures included the creation of long-term mechanisms for managing local debt risks and the optimization of central and local debt mechanisms. Additionally, greater support is intended for the real estate market, closely intertwined with local finances, as well as small and medium enterprises (SMEs).
This prioritization of local debt issues in the conference aligns with the recent support for local governments and their Local Government Financing Vehicles (LGFVs), which play a significant role in the stability of the financial sector and have been utilized by local governments for financing infrastructure projects. This support comes in the form of debt relief measures initiated by the central government. (In mid-August, the total debt held by LGFVs was estimated by the International Monetary Fund (IMF) to be RMB 66 trillion ($9.1 trillion).) For example, on October 24, 2023, the central government unveiled a proposal to release an additional RMB 1 trillion in sovereign bonds during the fourth quarter of 2023. The funds raised from this issuance will be allocated to specific local governments to support infrastructure reconstruction efforts. This move is considered a clear signal of support, as the issuance of these bonds by the central government will not contribute to the debt burden of local governments, unlike the issuance of local bonds.
So, what can be expected regarding the mitigation of local debt risks? Thus far, conventional measures such as debt swaps, loan rollovers, and the potential issuance of debt by the central government to bail out localities have been mentioned. Another common support measure for local governments, which has been applied in the past, is the issuance of local bonds at more favorable interest rates (around 3%, while LGFVs often pay 7-10% interest). As for longer-term restructuring, the situation is somewhat unclear. What can be understood by long-term mechanisms for local debt?
This could, for example, refer to the optimization of the system for local government bonds (Difang Zhengfu Zhaiquan), which can theoretically be controlled by setting debt limits. Currently, so-called “refinancing bonds” often transfer LGFV debts into the bond system. The pursuit of this strategy could also be targeted by the central government in the future, thereby minimizing the risks of LGFV debts. In general, local governments in China have been officially allowed to issue bonds since 2015 for the financing of various infrastructure projects. Since then, the number of outstanding bonds has increased steadily (see Graph 1+2). However, due to the perceived risks, the debt limit cap has been strictly enforced, leading local governments to borrow money from other sources, including the shadow banking sector. In the future, the restructuring of this system for more sustainable financing would need to not only involve the capping of debt limits but also the establishment of a meaningful cap that enables local governments to better meet their financing needs through official mechanisms.
Should the central government focus on standardizing the bond model, the question still remains about how the debts under the new system can be repaid, as the revenue system has not changed, and local governments, for example, lack sufficient tax revenues for sustainable bond financing. My research on local bond systems in China has shown that especially “special bonds” (Difang Zhengfu Zhuanxiang Zhaiquan) (see Graph 2) – this type of bonds increasingly used for fiscal support by local governments – were financed to a high percentage (over 87 percent) by revenues from the land market (see my paper “Debt Risk after the Reform – China’s Land-Backed Municipal Bonds” https://hasp.ub.uni-heidelberg.de/journals/asien/article/view/20425).
Therefore, changes of the local revenue structure would need to be implemented in conjunction with the announced reforms of local debt mechanisms, as these issues are now closely interconnected. Currently, it remains to be seen when concrete reform ideas will be presented in the near future.