China’s ‘two sessions’ 2023: how debt-saddled local governments underscore Beijing’s moderate GDP target

Talk of financial risk management at annual meetings is high-profile reassurance of leadership’s repeated vows to curb such risks and alleviate revenue problems
‘Already high’ government debt pressure could lead to reduction in special purpose bonds issued by local authorities to pay for major infrastructure projects

Two Sessions 2023 (Lianghui)

Amanda Lee

Published: 1:00am, 9 Mar 2023

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China’s moderate economic growth target for 2023 sets the tone for more debt-control measures among local governments amid a growing chorus of concerns over default risks and uncertainties surrounding China’s economic recovery, according to analysts.

Premier Li Keqiang’s final work report to the annual National People’s Congress (NPC) on Sunday highlighted the heightened risks from monetary debt at local levels of government across the country.

And while calling for the curtailing of incremental new debt and the reduction of outstanding debt, Li also said the local-debt-maturity structure needs to be optimised, with lower interest burdens.

Beijing aims to boost its gross domestic product (GDP) by around 5 per cent this year, a relatively moderate growth target that will allow for more leeway to focus on resolving long-term challenges, which include big piles of government debt, analysts said.

Hit by the impact of the pandemic and China’s restrictive zero-Covid policy, many regions across the country are facing economic hardships, with a broad plunge in revenue from land sales and with less tax revenue from tax breaks over the last three years.

Elevating the discussion of financial risk management at the ongoing “two sessions” parliamentary gatherings in Beijing was in line with comments made by President Xi Jinping in an article published last month, Nomura analysts said on Monday.

The article, appearing in Qiushi, the official journal of the Communist Party, called for efforts to effectively forestall and defuse major economic and financial risks, including the systemic risks arising from the property sector, financial risks and local government debt risks.

“Coupled with the conservative growth target, this may signal a potential shift in focus to tackling financial risks and hidden debt among local governments at some point this year, particularly in the second half [of the year], after the economic recovery has largely stabilised,” Nomura said.

Oxford Economics’ lead economist, Louise Loo, said transfer payments from the central government to local governments will be 3.6 per cent larger this year than they were in 2022, and that this is a likely reflection of authorities’ desire to manage local government debt risks amid the continued murky outlook for revenue collections.

“We will have to wait until March 13, at the conclusion of the NPC, for details on the government’s spending priorities,” Loo said on Monday.

Tianfeng Securities’ chief macro analyst, Song Xuetao, said that Beijing’s overall fiscal arrangements this year were relatively moderate, with just 3.8 trillion yuan (US$545 billion) allocated for special purpose bonds, which are mainly used to fund infrastructure spending – or about 200 billion yuan less than what was issued last year.

02:03

China targets to boost gross domestic product by ‘around 5%’ in 2023

“The reason is simple, local government debt pressure is already high,” Song said on Monday.

Beijing has sought to curb the growth of the so-called hidden debt, issued by local government financial vehicles (LGFVs), entities created to circumvent borrowing restrictions and used to channel funding for infrastructure spending.

From 2015-19, the central government encouraged debt-swap programmes with local governments to replace hidden debt with a new debt quota from the Ministry of Finance, to ease financial risks.

“We believe that it is possible to see a new round of local government hidden debt replacement on a larger scale this year,” Song said.

China’s economic planner, the National Development and Reform Commission (NDRC), has already rejected a batch of infrastructure projects submitted by local governments this year.

The cited reasons vary. Some of the spending plans “were not thought out thoroughly”, “did not provide enough economic benefits in terms of the investment needed”, or perhaps they “appear on the list of prohibited projects”, the NDRC’s investment research institute director, Wu Youhong, was quoted as saying by state media on Monday.

Last year, the NDRC revised its list of approved projects that fall under special purpose bonds, in a bid to better improve fund use and to avoid costly projects that add to debt loads.

Ming Ming, chief economist at Citic Securities, estimated that there will be a total of 4.03 trillion to 4.74 trillion yuan worth of hidden debt that will need be replaced with on-budget borrowing this year if Beijing renews its push for a debt swap at local governments.

Ming also estimated that there would be somewhere between 9.22 trillion and 10.84 trillion yuan worth of LGFV debt that may need to be repaid this year, meaning that, altogether, debt related to LGFVs is likely to amount to 12 per cent of China’s GDP last year.

NPC deputies from the Inner Mongolia autonomous region and Yunnan province have urged the central government to provide more support, such as more debt quotas and transfer payments to the regions, to help alleviate their debt problems.

The Inner Mongolia Audit Office said in a report last year that the coal-rich region had failed to meet its debt-curbing target.

China’s recent tilt toward greater fiscal conservatism is aimed at managing the country’s large local government debt

Susan Chu, S&P Global Ratings

“Generally speaking, regions with relatively weak qualifications will have relatively higher implicit debt pressure, so the demand for hidden debt swaps will also be correspondingly stronger,” Ming said last month.

US rating agency Standard & Poors said in a research note last week that it expects local governments to let some state firms slip into default or restructuring after years of record debt, depleted revenues and widening deficits.

“We believe China’s recent tilt toward greater fiscal conservatism is aimed at managing the country’s large local government debt,” S&P Global Ratings credit analyst Susan Chu said.

“However, the many domestic and international investors who have invested in state-owned-enterprise bonds may get left in the lurch.”