The hidden debts of Chinese local governments has continuously broken records in recent times. Up to half of them have fallen into financial distress and are waiting for financial support from the central government. The banking system, as a matter of fact, has also fallen into crisis. It all stems from real estate defaults and huge spending because of the zero COVID policy. Faced with this situation, Chinese leader Xi Jinping was forced to recommend “Common Prosperity” for forced property harvesting while Li Keqiang issued an administrative order on the matter.
China’s local governments’ record high hidden debt
Local governments in China issued 1.41 trillion yuan ($205.58 billion) in bonds in June, an increase of nearly 80% compared to June 2021. This has surpassed the record 1.3 billion yuan ($189.5 billion) in May 2020, as China focuses on stabilizing the economy due to the impact of the Wuhan pneumonia (COVID-19) pandemic.
A September 2021, Goldman Sachs report showed that the hidden debt of Chinese local governments has swollen to more than half the size of the country’s economy. The Goldman report said that the total local government bond vehicles (LGFV) debt had grown from 16 trillion yuan in 2013 to about 53 trillion yuan ($8.2 trillion) at the end of 2021. This is about 52% of gross domestic product and is larger than the official outstanding government debt.
China’s local government debt has always been a “black box” with the central government and the People’s Bank of China (PBOC). The problem is, the local government is powerless to solve the debt because the main source of revenue is land sales, which has been slowing down because transactions have stopped, while spending on zero COVID policy is aggressively gnawing away at the pockets of local governments.
To fill the funding gap caused by shrinking land sales, Goldman recommended that the government increase the bond quota from 3.65 trillion yuan ($532.16 billion) in 2021 by more than 500 billion yuan ($77 billion) for 2022. This financial statement, which was based on the calculation of 2,000 collected local debt vehicles, has arrived at these conclusions:
- Liabilities of local government financing vehicles are mainly from construction, transportation, and industrial sectors – these three sectors account for almost 40% of total LGFV debt in 2021.
- Jiangsu tops all provinces in terms of loan size with about 8 trillion yuan in 2020
- About 60% of bonds issued by local foundations are used to repay debt maturing in 2020-2021, rather than new investments.
Local government debt in China is so bad that, from the end of 2021, some localities owe civil servants salaries, public service officials have not been paid for months, and many belt tightening measures have been implemented. According to Chinese media, because bus drivers in Pingdingshan city, Henan province have not been paid for eight months, they went on strike in November 2021. This problem could be the result of many Chinese local governments running out of funds.
According to Nikkei Asia, a regulation introduced by China’s State Council in 2016 required that local governments whose interest burden (that is interest payable) exceeded 10% of state budget revenues, must implement fiscal consolidation plans. S&P Global estimates that between 10% and 30% of China’s approximately 300 provincial administrative units will exceed this threshold by the end of 2022, up from less than 5% in 2020.
The financial burden of local governments mostly stems from the central government’s zero COVID policy. For example, the Chinese Communist Party requires proof of a negative PCR test result for the previous 72 hours to enter restaurants and public places, and the city will cover the cost of testing for residents.
Chinese stockbroker, Soochow Securities, estimates that routine mass COVID testing in all of China’s biggest cities, such as Beijing and Shanghai, could cost up to 1.45 trillion yuan ($211.41 billion) per year.
Real estate collapse results in the wreck of local financial and banking sector
China is a country that worships growth achievement, which means that whichever local government achieves high growth will satisfy the central government, and its leaders will quickly be promoted and favored.
In turn, the central government also creates conditions for local officials to have the opportunity to promote growth. China’s 2015 Budget Law allows all revenue from land to be left for local spending and reinvesting in infrastructure. In addition, local governments are allowed to issue special local bonds to finance investments in specific local projects (a type of structured finance, which has a much lower standard of safety than standard debt). The problem is that all special bonds issued by local governments do not need to be reported to the central government and are not accounted for in China’s government debt. Of course, the “creative” accounting recognized by China’s Budget Law is completely different from international standards and practices for government debt statistics.
Meanwhile, controlled by the one-party regime, all local banks are under the direction of the local government.
Therefore, when the local government issues debt, local banks will use the money raised from the population to buy local government debt. The local governments will organize bidding and sell land to local real estate development enterprises. These enterprises also borrowed money from local banks (even under pressure from local authorities, it was impossible not to lend) to implement the winning project and pay the local government. The local government takes this money to repay the local bank debt.
Therefore, when real estate cannot be sold resulting in the prices plummeting, businesses cannot repay the banks, and the local governments cannot collect money from both the government and real estate developers, such as Evergrande. This is the reason why local governments are calling for civil servants and residents to buy houses.
In recent months, the CCP has been plagued by protests from people in Henan province. The are out in front of banks because they were unable to withdraw or transfer their deposits. The customers lined up in front of big banks like Bank of China, Shenzhen city from 6 am wanting to withdraw money.
Chinese banks’ running out of money resulting in liquidity crises has been spreading from province to province, from small local banks to big ones. As usual, China shocked the world by using underground police to forcefully suppress protesters. They used blockades, travel bans, and tracking from the ‘anti-COVID’ app to ban bank customers from leaving their homes.
China is in an extreme financial predicament
According to data from China’s Ministry of Finance, remittance payments from the central government to local governments in 2022 are expected to be nearly 9.8 trillion yuan ($262.44 billion).
After reviewing the 2021 figures, Finance Minister Liu Kun said central financial revenue exceeded 9 trillion yuan ($1.31 trillion). Calculating the numbers simply, not to mention the figures of previous years, the CCP not only has to spend 100% of the previous year’s proceeds, but will also have to offset an additional amount of about 800 million yuan to cover the public budget in 2022. However, besides that, the state also has to spend some on extras like defense, decreasing foreign import and export tax rates, and the CCP’s huge administrative expenses.
To further corroborate this hypothesis that the Beijing government has run out of money, on August 16, Chinese Premier Li Keqiang held a meeting in Shenzhen to order the four eastern provinces to collect and hand over the central financial resources. This shows that the CCP is in dire need of money.
Six provinces, Guangdong, Jiangsu, Zhejiang, Shandong, Henan, and Sichuan account for 45% of the country’s total economic output and are the “pillars” of the country’s economic development. Four coastal provinces (Guangdong, Jiangsu, Zhejiang and Shandong) contribute more than 60% of their local government’s net income to the central government. This is a potential source of revenue that can improve the CCP’s financial situation.
Given the current situation, the importance of increasing revenue from key economic provinces is inseparable from ensuring basic government operations. However, the financial situation of the four coastal province is not very optimistic.
According to data from China’s National Bureau of Statistics, in the first half of 2022, Guangdong’s public budget revenue was 673 billion yuan ($98.12 billion), down 11.4% year-on-year; Zhejiang was 498.4 billion yuan, down 6.2% year-on-year; Jiangsu province was 463.9 billion yuan, down 17.9% year on year, and Shandong province was 395 billion yuan, down 8.2% year on year.
The fire is impossible to put out
The stagnation of the real estate market has left local governments, almost run out of money. Nothing seems to be able to save China’s property defaults. Thirty real estate businesses have defaulted on $1 trillion of debt. Tens of billions of dollars of real estate corporate bonds are at risk of default in the second half of 2022 because of the due date.
Three of the top five issuers — Evergrande, Kaisa Group, and Sunac China — have defaulted on their U.S. bonds. Then another real estate developer Shimao Group (Hong Kong) was unable to pay the interest and principal payments on an offshore bond worth $1 billion. This is the latest blow to China’s plunging real estate market.
Affected by the downturn of the real estate market, income sources from deed tax and land value-added tax were also significantly reduced. The CCP has therefore made moves to stimulate real estate demand.
On August 16, a viral online video showed Deng Bibo, secretary of the Shimen District Party Committee of Changde City, Hunan province, speaking at the opening ceremony of the “2022 Real Estate Expo of Shimen District Conference”: “I hope that after our meeting today, comrades and all leaders will take lead in buying a house, if you’ve already bought one, then buy a second, if you’ve already bought two, then buy a third, if you’ve already bought three, then buy a fourth.”
‘Common Prosperity’ to coercively harvest rich people’s assets to save government debt?
China’s financial situation from central to local government is increasingly critical. Growth has fallen sharply in the past four decades, and Xi has repeatedly mentioned the “Common Prosperity” initiative; capital mobilization is a beautiful way of sugarcoating the truth, which is to coercively harvest the rich to offset the government debt at all levels.
He lated common prosperity to related common prosperity to raising the incomes of low-income groups, promoting fairness, making regional development more balanced, and stressing people-centered growth. This included a pledge to “reasonably regulate excessively high incomes, and encourage high-income people and enterprises to return more to society.”
This spooked China’s elite and they have sought to move their wealth out of the country.
Henley & Partners, a London-based immigration and investment consulting firm, pointed out that this year, an estimated 10,000 rich people in China are looking to emigrate. On average, each person will bring about $4.8 million. As a result, it is estimated that as much as $48 billion will flow out of China.
Tang Jingyuan, an expert on the Chinese economy based in the United States, told The Epoch Times that the main reason behind the exodus is the Chinese authorities’ efforts to strengthen the country’s economic power at the expense of private enterprise.
According to Tang, rich people will take away a sizable amount of capital in a “very short period of time.” However, the rapid transfer to foreign accounts will have a direct impact on the CCP’s foreign exchange system in the short term threatening “the very foundation on which the system is built.”
Tang added that as “living water” (liquid assets) continues to pour out, the social wealth base on which people depend will also continue to decrease.
“With the massive transfer of wealth, investment and employment opportunities for businesses in mainland China will also decrease rapidly, and the inevitable result will be a widening gap between the rich and the poor,” he warned.
In the long run, Tang predicts that as China’s backbone continues to evaporate, more educated people and young professionals will be forced to find labor-intensive jobs just to make a living – leading to a society that would “lack innovation and intellectual resources.”
At that time, those who can create jobs for Chinese people will move abroad. Those who stay will live in a state of joblessness, limited income, not daring to spend, leading to a failure to generate demand and promote supply and production activities to take place. This is a vicious cycle that makes China’s already difficult financial situation worse.