18.03.2018

3 Local Government Debt and Lianghui

What we thought was significant in the Lianghui 2018 (III)
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. Song Hai's report to the Lianghui (March 2018).

Source:
全国政协委员、十二届全国政协副秘书长、民建中央原副主席 宋海
中共十九大报告提出"健全金融监管体系,守住不发生系统性金融风险的底线"。地方政府债务带来的财政金融风险已经成为当前经济运行中最主要的风险之一。

Song Hai's report to the Lianghui begins with the recommendation that control mechanisms must be defined as soon as possible. The financial situation created by local governments is one of the main risk factors (最主要的风险之一) in the current situation.

The speech opens with some rather blunt remarks, in the kind of language that has not been unusual under the Xi Jinping / Li Keqiang administration, during which time the fight against maladministration in the provinces seems to have been stepped up.
Although countless measures have been implemented in order to pay off and contain debt and reduce the risks associated with the provinces' financial exposure, ‘local governments have violated laws and regulations and hidden debts', and today the danger caused by this situation cannot be ignored.

Song Hai then sets out the main reasons for this worsening situation: 1) the data for 2016, despite maintaining China's situation within tolerable limits - particularly compared to other countries -, shows that the local governments of some provinces have violated laws and regulations and hidden their debts, thereby contributing to the current worsening situation; 2) most of the debts incurred are very diverse and carefully concealed and also involve financial companies, government institutions and private enterprises. Debt in the construction industry (buildings and infrastructure) is high, diversified, carefully hidden and difficult to identify. The overall data for 2016 shows that total exposure is distinctly high. Of particular significance is the fact that ‘a growing number of urban investment projects have been supported by issuing bonds placed on the foreign investment market, thereby effectively increasing the government's total debt'.

This is followed by a series of guidelines that local governments are recommended to follow in order to reduce the scale of the problem and bring under control what is currently seen as a high-risk factor.

Song Hai suggests introducing tighter controls over local government activities; improving and bolstering the provisions of resolution No. 43 issued by the State Council 2014, of which our readers are already aware; and the creation of government-controlled local agencies that will merge local government debt and management resources into a single platform to provide streamlined management of capital flows and terms of debt repayment and debt exposure. The focus is on strengthening management and adopting scientific solutions. Since the Maoist era, the term "scientific" has been used in Chinese terminology to emphasize the contrast with fanciful programmes, vaguely inspired by the support and "creative" force of the masses. In actual fact, use of the term "scientific", in the context of "scientific socialism" and "scientific development", goes back much further in time. It first appeared in party documents immediately following the tragedy of the Great Leap Forward (in the late Fifties), and is the recurrent Chinese expression used for rejecting projects that lack economic solidity and budgetary planning, and goals to be achieved but which rely - like the Great Leap Forward in fact - on the mobilization of the masses, their fervent contribution, revolutionary enthusiasm, and so on.

The second point in Song Hai's recommendations might have been taken almost literally from the 2014 reports and those of the Wen Jiabao era. The recommendations are not wrong, but as they are repeated almost identically we may well wonder to what extent they were followed.

Thus, they stress the creation and application throughout China of standard debt management parameters, also designed to make it harder to engage in the countless ways of concealing debt; local governments are recommended to issue bonds to raise funds for specific projects; and local governments offices dealing with debt management are urged to turn themselves into market-oriented companies operating according to market principles. Further recommendations include being much tougher over debt control; preventing the establishment of law-breaching procedures that hide incurred debts and financial exposure; and not allowing money to be spent on initiatives with "high political value". The debt being incurred - states Song Hai - threatens the wellbeing of future generations.

The third and fourth points seem to repeat - yet again - what had already been stated in the State Council 2014 resolution. We do, however, see the appearance for the first time of much less generalized statements about local government (though perhaps they had already appeared in other documents). It is recommended that a "scientific" definition of the areas of competence and powers of local government should be adopted. There should be a precise separation between local government powers and financial liabilities, which should be borne by agencies separate from the government. And, once again, there is an emphasis on reducing the degree of autonomy, bolstering controls and strengthening inspections. Among the practices already prohibited in 2014, there is the renewed prohibition to use funds allocated to routine public administration expenditures for particular projects, however important these may be; the prohibition to use the financial resources of government controlled or public sector enterprises; and the prohibition to transfer public land or assets to companies in order to boost their economic and financial resources.

Lastly, the fifth point goes over considerations previously expressed during other lianghui sessions and in other political documents of the State Council. The local government's budget and debt must be approved by the local people's congress; debts must be included in the budget; it must be possible for debts to be controlled by the people, who have a right to know how the money has been applied for, how it has been used and when it will be returned.

The speech ends with the recommendation to expose, report and prosecute any breaches of the law and of established procedures.

Comment

The report starts with a belligerent tone and for the first time uses words that were contemptuously rejected when used by rating agencies in 2010 and 2011. Back then, they were defined as an expression of Western capitalist aggression against China's growth drive and investment policies. As we have seen, this is not the first time that the Chinese government is so worried about debt. But while in the past rating agencies were accused of using the provinces' spiralling debt as a weapon to hit China, today they are not even mentioned, and it is quite openly argued that local government debt is endangering the country's development, is the greatest risk factor at the financial level and is a burden that will ultimately be borne by future generations.

New developments include the political decision to define more clearly the limitation on the powers of provincial governments and their areas of responsibility - but it is not at all obvious how far this will be implemented through State Council laws and regulations. The aim is to separate the provincial governments' political and administrative role from the management of financial resources, possibly through the creation of "debt agencies" that provincial governments would have to refer to before undertaking any actions leading to new debts. The external observer, however, cannot fail to notice [possibly due to the intrinsic limitations of this enquiry] that no significant and concrete step seems to have been taken in defining the said limitations and areas of responsibility. It may be that such a step is not envisaged, or that it may not be possible, or again that it may have been moved to other levels. It could have been shifted - as we increasingly believe - to the level of a more generalized anti-corruption campaign. The latter's very broad formulation gives the government considerable leeway, allowing it to define as moral infringements what in other countries would be deemed infringements of an administrative character.

But in this area too - as anyone who is familiar with China's history knows all too well -, the country has a long tradition of disguising economic and administrative problems as broader moral issues. It is as if the significance and gravity of the failure to comply with the law and the relevant administrative procedures were ascribed not to an error or an illegal practice in the performance of administrative duties but to a moral fault, and should therefore be treated as such.

These considerations would thus seem to lend strength to the belief that the fight against corruption conceals some important parts of the central government's fight against the incompetence, lack of professionalism and sloppiness of local government.