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Macroscope | In China, shifting debt burdens onto local governments will prove costly in the end
- China’s old playbook of using off-budget infrastructure spending to boost growth is saddling local governments with unmanageable levels of debt
- Instead of focusing on keeping its own balance sheets clean, the central government could save money and minimise risks by assuming this debt itself
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Whenever China’s GDP growth is below target, successive governments have relied on the same tool: government spending on infrastructure to stimulate the economy. But the success of fiscal stimulus requires getting the details of implementation right.
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Two challenges stand out. The first is financing. While Chinese policymakers rely on fiscal spending to help achieve the official growth target, they are uneasy about the central government’s rising leverage ratio – debt as a percentage of GDP – and about moral hazard at the local government level. Given this, they are reluctant to finance infrastructure investment through the general public budget.
Instead, the authorities use other “budgeted funds”, including local government special-purpose bonds (SPBs) and revenues from the sale of land rights. Such financing is augmented by “self-raised funds”, obtained mainly through municipal-bond issuance, bank loans, and state-owned enterprises.
One striking feature of the funding structure is that the more expensive a source is, the larger its share of total financing. So, the general public budget – which costs nothing, from an investors’ point of view – accounts for a small share.
According to my estimates, in 2021, that share was 10.2 per cent, with the central government’s contribution amounting to just 0.1 per cent. Funds raised from municipal-bond sales – which are far more expensive – accounted for more than 30 per cent of total infrastructure funding.
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By relying on funds raised through the capital market and commercial banks, China makes its infrastructure investments far more costly than necessary. And while China’s approach of choice protects the central government’s deficit-to-GDP ratio, it places a heavy burden on local governments’ budgets, especially because infrastructure investment is generally unprofitable and unable to generate large cash flows.
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