China’s treatment of local debt ‘ulcer’ threatens growth target

Beijing/Hong Kong: China is scrapping a string of infrastructure projects in indebted regions as it struggles to reconcile a need to save money with this year’s target for economic growth.

Beijing has ordered a dozen highly indebted areas, many of them less-developed and far from the coast, to curb infrastructure spending as it tries to unwind a decade-long investment binge many believe is unsustainable.

But analysts say the austerity drive may make it even more difficult to achieve the ambitious 5 per cent target for annual growth set by Premier Li Qiang during China’s “Two Sessions” political gathering this month — with potentially far-reaching implications for the global economy.

Among the projects being scrapped are a highway in Yunnan province and a tunnel in Gansu. Guizhou province has sidelined so many infrastructure schemes that provincial outlays for major projects this year are projected to fall 60 per cent.

China’s economy is still bearing the impact of a real estate sector crisis that began after authorities sought to rein in developers’ vast borrowing. “In 2021 they went after property, this year they have been addressing the infrastructure side of the equation and local government debt,” said Michael Pettis, a finance professor at Peking University.

Investment in property and infrastructure had been significant sources of economic expansion, Pettis said. “So the question is: where is growth going to come from?”

In a policy document seen by the Financial Times, the State Council, China’s cabinet, ordered 10 debt-laden provinces and regions and two major cities to strengthen oversight and approvals of government projects.

The rules, which took effect on January 1, bar the 12 areas from launching many types of new projects, such as building highways or government buildings, and call for a suspension of some early-stage schemes.

“Governments of all levels better get used to belt-tightening and start to understand that this is not a temporary need, but a long-term solution,” finance minister Lan Fo’an told a press conference during the Two Sessions, which closed on Monday.

Officials from several provinces sought debt relief from state bankers in discussions on the sidelines of the parallel sessions of the National People’s Congress, China’s rubber-stamp parliament, and the Chinese People’s Political Consultative Conference, an advisory body.

Provincial delegates hailed the government’s clampdown on infrastructure spending. “If you have an ulcer and you ignore it, you may just look healthy but actually are not,” said Wang Chunru, a CPPCC member from debt-stricken Inner Mongolia, one of the 12 province-level governments targeted. “Only by treating it and getting rid of it can you actually live longer and better.”

But analysts at Goldman Sachs describe the push to shelve projects in some of the most indebted areas, while providing enough fiscal stimulus elsewhere to boost economic growth, as a “balancing act”.

Beijing is betting that increasing infrastructure investment in richer coastal provinces such as Zhejiang or Guangdong can offset the cutbacks in the 12 targeted areas, which include the province-level cities of Tianjin and Chongqing and rustbelt north-eastern provinces.

Together, Goldman said the 12 areas accounted for 22 per cent of China’s fixed-asset investment and 18 per cent of gross domestic product last year. Fixed-asset investment was expected to fall this year by 60 per cent for the western province of Guizhou and between 11 per cent and 15 per cent for several others, Goldman said.

At the NPC, Premier Li said: “We will make concerted efforts to defuse local government debt risks while ensuring stable development.” But analysts believe that will be easier said than done.

Li has signalled more support for the economy in 2024, with plans to issue Rmb1tn ($140bn) in long-term central government special bonds, instruments used to raise extra funds. This should help overly indebted local governments to deleverage, said Chris Beddor of Gavekal Dragonomics. The deleveraging process started last year, with state banks restructuring debts. Local governments have also issued more than Rmb1.4tn in bonds to repay implicit debt from off-balance sheet financing vehicles.

“It’s clear that policymakers think they can get around this by essentially having the central government issue more bonds and do more of the fiscal work itself for the local governments while at least some of them engage in a sort of fiscal retrenchment,” said Beddor. “I think it creates a lot of room for policy error.”

While it was not his “base case”, it was possible the government could fail to calibrate the adjustment properly and the economy would actually “get a drag instead of a push”, Beddor said.

The enthusiasm for a spending clampdown expressed by some attendees of the Two Sessions is also likely to fuel economists’ concerns about the strength of Chinese consumption. “All of us Chinese people need to tighten our belts, not just local governments,” said Zhang Shuyang, a Guizhou NPC delegate. “Living frugally is our glorious tradition as the Chinese nation.”

Guizhou, one of China’s poorest provinces, is now home to nearly half of the world’s 100 highest bridges, including four of the top 10. Yuekai Securities estimates the province’s infrastructure building spree has left it with total debt, including off-balance sheet liabilities, at 137 per cent of its gross domestic product.

Chinese local government debt, including off-balance sheet financing vehicles and shadow credit, was probably equivalent to between 75 and 91 per cent of national GDP in 2022, according to a paper last year by Victor Shih and Jonathan Elkobi of the University of California San Diego.

Twelve province-level governments had outstanding bonds alone equivalent to more than 50 per cent of their GDP, they wrote. China says its total central and local government debt is less than 51 per cent of GDP.

In the Chinese capital last week, Guizhou governor Li Bingjun said he understood living frugally was the new norm and pledged to strictly manage projects and cut expenditures. “We continue to reduce various festivals, forums and exhibition activities,” Li told reporters. “If it’s not necessary, we don’t hold it.”