18.03.2018

2 Local Government Debt and Lianghui

What we thought was significant in the Lianghui 2018 (II)
China's surging local government debt is spiralling out of control and could potentially trigger a financial crisis, with devastating consequences for the country. The views of the Party and Chinese government bodies. The State Council's 2014 recommendations.

务院关于加强地方政府性债务管理的意见发〔201443
On 21 September 2014, a few months after China's provincial governments were criticized by Wen Jiabao (for blatantly false financial statements, unscientific data, grossly understated deficits, financing through illicit channels, and so on), the State Council intervened in the complex relationship between provinces, central government and debt by publishing a series of recommendations which it urged local governments to follow.* The intention to adopt what may seem like a soft approach is clear even from the title of the document. The Chinese State Council actually uses this formula quite frequently, preferring to present its recommendations as guidelines, and without stressing the authoritarian nature of the provisions. For years, it was thought that these ‘suggestions' were then fully accepted and implemented by the state, the provincial administration and the political system. As we shall see, however, this was not the case. Equally significant is the stark contrast between the soft language used and the dramatic nature of the problem, which the State Council views as crucial for the nation's development ("为加强地方政府性债务管理,促进国民经济持续健康发展").

The State Council's recommendations - a major resource for the historian - set out the procedures that have to be abandoned and replaced with others, thereby providing a detailed picture of local government in China's provinces.

In terms of basic principles, the document defines the key points of all correct administrative conduct. They include making the channels of local government funding more transparent, controlling and eliminating all forms of hidden financing, adopting standard measures across the public administration, and formally and resolutely forbidding local government to deal with its debt in an illegal manner.

Definition of responsibilities (分清责任). In order to clearly define who is responsible, and for what, local governments are prohibited from transferring the debt incurred by local authorities and local administrations to private enterprises. The debt of enterprises must under no circumstances be transferred to local governments. Any party borrowing money shall assume the risk connected with their investment.

In terms of management, anything connected with debt and investments must be included in the local government's budget and comply with the basic rules of a) budget management, b) definition of the intended purpose and utilization of the funds, and c) debt repayment terms.

This is followed by section two, which sets out the standards of financial and administrative conduct and specifies the following:
- When borrowing money, local governments must act in accordance with the law. Money may be borrowed upon approval by the State Council, governments of provinces, autonomous regions and municipalities. At every public administration level, from the smallest county to the largest provincial government, a clear boundary must be drawn between enterprises and local government. ‘Local government may borrow money exclusively from public institutions and their local agencies and not from enterprises or other types of institutions.'

Where the reasons for borrowing money are real and cannot be deferred, the local government is authorized to issue bonds, to be repaid mainly through public guarantees.

Investment involving private capital has to take place through franchising agreements to finance specific services that can guarantee a certain amount of debt repayment over time. Investments, however, must be made in accordance with market principles, hence local governments shall only undertake projects that create debt if these make economic sense, and only if the shareholding of the private enterprise is based exclusively on a market-driven return on investment (in other words, the private investor cannot at some later date ask the local government to assume the repayment liability if the investment proves be unprofitable).

Local governments are required to carry out scientific and market analysis of the investment and to strengthen control bodies. They will ensure that there is no shift from the original purposes that led to the financing request.

Section three. Implementation of management and control instruments by the public administration.

There are national scales that must be complied with setting limits to the amount of each debt for each province. The quotas determined by the State Council, the National People's Congress and the Ministry of Finance must be adhered to. In each case, any further debt raised must be approved by the State Council.

Local government debt is subject to clearly defined restrictions that must be complied with. Specifically, local governments may not borrow from private enterprises. Any debt raised must not be used to cover routine public administration expenses. Resources allocated to routine public administration expenditures must not be used for investment purposes, even if such investments were to be driven by market consideration.

Every form of local government debt must be included in the budget. No expenses can be excluded from it. Moreover, if a debt is included in the budget, details must be provided as to how and when the local government intends to reduce the debt exposure.

Section four. Control and management of risks associated with local government debt.

Debt management and control procedures must be defined and take into account the limits to debt determined for each individual region by the Ministry of Finance.

Every local government and every local government official is personally liable for the debts raised and their evolution. Where at-risk investments or excessive debts have been identified, the local government concerned is required to report the non-recoverable amounts to the Central Government and Ministry of Finance, which will in turn initiate the appropriate debt disposal plans to be applied.

Strengthening discipline and compliance with the law. No one is authorized to borrow money outside the scope of the budget, make requests for illegal financing from third party institutions, transfer their debt to private enterprises or raise debt for the management of current expenditure. Moreover, local government will be required to regulate publicly any land transfer to private enterprises, and put an immediate stop to any form of illegal financing activities and illegal transfer of land.

Further sections follow, which are no less important but do not essentially change the picture outlined above.

Comment

We cannot assume that the behaviours described here, and which the State Council stigmatizes and points to as ‘illegal,' have all actually occurred, or have occurred everywhere. It may be that some instances of misconduct or patently criminal conduct have been outlawed here purely for the sake of completeness. Anything is possible. And we certainly have sufficient regard for the complexity of China's administrative and economic life to be prudent in this respect. Even so, as is probably clear to anyone reading this, when so much and such persistent emphasis is placed on blatantly inappropriate if not outright criminal behaviour, then something is occurring on a much bigger scale.
Governments running up unauthorized debts; governments borrowing money from private institutions, we can well imagine in exchange for what; debts raised for ordinary public administration expenditure; unsound investments initially undertaken by private enterprises and later absorbed within the local government's budget; irregular financial statements; concealment of information; use of public debt for private purposes; and the list goes on. The 2014 State Council provisions point to a situation that seems almost out of control. From these provisions of the State Council, the Chinese state - which at the political level is presented as one of the last totalitarian systems in the world - seems strong enough to afford to speak openly about its problems. But is also seems dangerously weak in the face of public maladministration, perhaps dishonesty, perhaps incompetence, perhaps autonomist stances by local governments bold enough to engage in financial practices that would be regarded as being of the utmost gravity in any country in the world (concealment of debts and deliberately falsified financial statements to hide what goes on at the local level).

While the world seems to be concerned about Xi Jinping as the new Mao (and in 2014 Xi Jinping was already the incumbent president and the State Council was headed by Li Keqiang), the 2014 provisions point to a major disconnect between the centre and the periphery, where the centre lays down the law and the periphery essentially does [not always and not everywhere] what it likes.

All these issues may be partly why Xi Jinping and the Party almost simultaneously launched a large-scale anti-corruption campaign. It isn't hard to guess what may have happened to officials who had borrowed money for private purposes and charged it to the local government's accounts, or had drawn up false financial statements, and so on. But the problem lies elsewhere: what is the situation according to Song Hai's March 2018 report?

NOTE

* Neither in the Chinese text nor in any of the available translations of 国务院关于加强地方政府性债务管理的意见 has the term "recommendations" been adopted by Chinese sources. Official sources prefer a mild approach, underlining the character of "opinions". Nevertheless provision No. 43 is an official document issued by the State Council and - on the whole - it seemed reasonable for us to view it as a "recommendation" in our comments.

(to be continued II/...)