China's top auditor revealed that some local governments used deceptive tactics to mask billions of yuan in hidden debt, despite official claims of significant reductions. This undermines Beijing's efforts to control financial risks.
The revelation of widespread debt concealment by Chinese local governments poses a significant threat to financial stability, potentially undermining Beijing's efforts to manage systemic risks and impacting the broader Chinese economy.
China's top auditor has revealed that some local governments have employed deceptive methods to conceal billions of yuan in hidden debt, undermining Beijing's efforts to mitigate financial risks. Official data suggests that local government hidden debt balances decreased to 10.5 trillion yuan ($1.5 trillion) by the end of 2024, but the audit findings highlight ongoing challenges in enforcing financial discipline.
Mounting hidden local government debt, largely held by local government financing vehicles (LGFVs), is a significant concern, with estimates ranging from $8 to $10 trillion. This off-the-books debt stems from a long-standing dispute over tax revenue between the central government and local authorities. Before the COVID-19 pandemic, LGFVs managed their debt through steady non-tax revenues. However, in the months following the pandemic's outbreak, hidden LGFV debt began to rise sharply, and many LGFVs are now reportedly nearing default, leaving local governments financially strained.
A study co-authored by Jean Oi suggests that China's central government's regulatory crackdowns on real estate income during the pandemic, combined with zero-COVID policies, created a 'perfect storm' that pushed hidden local government debt to new highs. The research utilized a province-level dataset from 2018 to 2022 to analyze the impact of COVID-19 on businesses, government fiscal responses, and local finances.
The roots of China's local debt problem trace back to 1994 fiscal reforms, which centralized tax revenues with Beijing, leaving local governments with persistent budget deficits. A 'grand bargain' was struck, allowing localities to generate non-tax revenues via LGFVs, which were state-owned enterprises designed to hold debt off-the-books on behalf of local governments. This system fueled rapid development for years, largely dependent on land finance, where local governments used land as collateral for loans and sold land to developers.