China’s Local Government Debt: A Hurdle to Growth and Development

The Chinese government’s efforts to stimulate economic growth have relied heavily on borrowing and spending, leading to a significant debt burden. This debt overhang poses a major challenge to China’s development. The recent Third Plenum session, however, failed to provide clear details on how the government plans to address this issue. While it was acknowledged that local government debt needs to be dealt with, the lack of a comprehensive program is concerning. Without effective measures in place, the burden of local government debt could continue to hinder China’s growth, even if the property crisis is resolved.

The heart of the local government debt problem lies in the use of local government financing vehicles (LGFVs). These vehicles were promoted by Beijing as a means for local governments to borrow large sums of money for infrastructure projects. By keeping the debt off the local government’s balance sheet and hiding it in the LGFVs, borrowing limits and public scrutiny were bypassed. However, this off-the-books “shadow debt” has grown to staggering proportions, estimated to be between $7 trillion and $11 trillion, twice the size of China’s central government debt.

These LGFVs have been behind the impressive infrastructure projects that have fueled China’s growth, such as apartment complexes, city centers, highways, bridges, and rail systems. Initially, these projects contributed to China’s economic progress and allowed the Chinese Communist Party (CCP) to take credit for the growth. But over time, the returns on these projects have diminished, making it increasingly challenging to repay the debt incurred. This unsustainable debt now poses a threat to the progress made.

The root cause of this predicament lies in the CCP’s centralized planning, which prioritizes political considerations over economic ones. As a result, the projects funded by LGFVs often reflect political preferences rather than economic needs. While this was less of an issue when China was underdeveloped and needs were obvious, it has become a hindrance as the country has progressed. The misallocation of resources has led to a less-than-adequate return on investment.

Credit-rating firms Fitch and Moody’s have downgraded China’s financial prospects, citing the likelihood that a significant portion of LGFV debt will never be repaid. Local governments are struggling to meet their obligations and provide essential services to their populations. Meanwhile, Beijing has lost a crucial source of economic growth.

To revive China’s economy, the government must find a solution to the LGFV problem. However, even if a plan is put forth, it is unlikely to be sufficient. The slow and tentative approach taken by Beijing in addressing the property crisis suggests that a comprehensive and effective plan may be years away. This means that China will continue to suffer from a lack of growth, which is essential to the CCP’s ambitions.

In conclusion, the Chinese government’s heavy borrowing and spending, facilitated by LGFVs, has resulted in a significant debt burden for local governments. The misallocation of resources and diminishing returns on infrastructure projects have made it difficult for these debts to be repaid. This local government debt problem poses a significant risk to China’s economic development. It is crucial for Beijing to address this issue promptly and effectively if it wants to revive the economy and achieve its growth ambitions.