China’s debt trouble: What do we learn from it?

Beijing’s excessive borrowing-led aggressive growth model. CCP has followed a brutal top-down approach in which ambitious growth objectives are dictated to the provinces. The Chinese way of regional development, in which the promotion of regional leaders was linked to regional modernization and development, erstwhile condoned, would now land under severe scrutiny by development economists and policy experts alike …writes Kaliph Anaz

Despite China’s better-than-expected quarter-three growth numbers, the Chinese economy is not all well. The Chinese dragon is crumbling under the burden of massive local government debt, reaching $12.58 trillion in 2022. Since 2021, Chinese subnational governments have been undertaking enormous cost cuts in public spending, including salaries and bonuses of its civil servants, safety nets for its elderlies, and other essential services. Economists who keep a vigilant eye on the Chinese economy have expressed their grave concerns about worsening conditions and drying up local finances.

Two main factors are leading to sharp cuts and resulting hardships faced by the people in China. As the COVID-19 lockdown persisted in China till late 2022, it hampered the economic growth of the local economies. Along with spending on maintaining lockdowns and other COVID-related expenditure, the tax cuts given by the government to private business in order to boost growth has further reduced the financial resources of the local governments. The second reason for the shrink is the drastic fall in real-estate prices. Property sales in China are plummeting over several months, deepening the housing crisis, and staggering its economic recovery. 

However, the primary culprit behind the mounting debt burden is more structural: Beijing’s excessive borrowing-led aggressive growth model. CCP has followed a brutal top-down approach in which ambitious growth objectives are dictated to the provinces. The Chinese way of regional development, in which the promotion of regional leaders was linked to regional modernization and development, erstwhile condoned, would now land under severe scrutiny by development economists and policy experts alike. CCP considers the economic growth of the provinces as one of the measures for evaluating the performance of local government officials. As Beijing runs an incentive-led strategy to induce growth, it compels local governments to take more and more loans to fund the projects and showcase growth. As a result, Local Government Financing Vehicles (LGFVs) emerged, a financing instrument used by local governments to fund social and physical infrastructure projects. The LGFV debts, often called “hidden debts,” are implicitly backed by local governments and mainly comprised of bank loans and bonds.

This has led to an excess supply of infrastructure as the economic returns on these loans and resulting projects are inadequate. Take the erstwhile impoverished province of Guizhou as an example. It has gained fame as the bridge museum for the world, housing several thousand bridges. However, as the heights of the bridge increased, so did the amount of borrowing to fund these ambitious projects. Resultantly, we observe a vicious cycle where more loans are being undertaken to execute even more infrastructural projects, all at the cost of the economic welfare of civil servants and the general public.

With the fall in their revenues to cover the looming debt, the local governments are using stringent measures, creating hardships for civil servants and the general public alike. As the local government debt problem has become more apparent, cities across China are either suffering or are on the brink of facing the heat of adverse fiscal measures. Governments are solving their dent problem with massive spending cuts. Experts have pointed out that local government debt problems are rampant, with 66 percent unable to pay their debts, and inland, less-developed regions would be the worst sufferers.

In Guangdong province, public officials are getting 75 percent of their salaries. The story is the same for even wealthier regions like Shanghai and Guizhou. In some regions, workers have not received their salaries for six months,[1] and in others, they are getting a very small proportion of their early bonus, if at all. About 66 percent of the public servants in Shanxi province have been laid off. In regions of Hebei province, the government has arbitrarily stopped public transportation as it has run out of funds to operate it. 

The local authorities have been devising “bizarre” ways to cut spending. Initiatives have been taken to reduce the medical reimbursements of senior citizens. Moreover, the indebted governments are desperately extending “controversial fines” and “arbitrary fees” on their citizens. Incidents have been reported from regions of Shanghai, Henan, and Guangxi where restaurant owners, truck drivers, and car users have been fined or made to pay high fees for trivial and illogical reasons.  News has been reported for levying unreasonably heavy fines on citizens for paltry issues like selling substandard vegetables or issues with weighing scales. This has led to a spike in the revenue collected by local governments through fines and fees, rising by 100 percent and more in many cities.

The excessively centralized Chinese system not only renders provinces at the diktats of the center, making them excessively dependent on the center, but also doesn’t provide much support to the provinces when they are in dire need. After setting unrealistic targets for the local governments, Beijing follows the “fight on your own” approach, extending limited help to the provinces. The provinces act in this way because they have incentives to do so.

Though there has been no episode of default in the past, that doesn’t rule out the possibility in the near future, given that the size of debts has ballooned up. To tackle this, as per a recent report by Reuters in October 2023, given the debt risk. State-owned banks have been asked to “roll over existing loans with longer-term loans at lower interest rates”[2].  Resultantly, the People’s Bank of China (PBOC) ordered major state lenders to extend their debt terms and make adjustments for repayment plans, along with reducing interest on outstanding loans to LGFVs.

Given this development, the state seems far from any fiscal restructuring. It is also unlikely that Beijing would change its fiscal structure and incentive schemes despite the dire situation as it would imply Beijing giving up on its control over its regions[3]. China’s fiscal capacity has become highly constrained as the revenues from investment-led growth are plummeting, something Beijing heavily relied on, along with a decline in tax revenues[4].

The dire debt situation in China makes us return to some basic questions: Growth for whom? At what cost? China may have reduced travel time between regions with super-advanced road and rail infrastructure, but at what cost? Is the bubble of Chinese regional growth about to burst?

Are we seeing a collapse of what was once celebrated by development economists as an innovative and incentive-driven regional development model of the Chinese economy? The answers would unravel with time.  However, the Chinese situation does provide us an opportunity to mull over the sustainability questions regarding the economic growth path. We derive some key economic policy lessons.

First, economic policy should not provide perverse incentives for pursuing economic growth. Due to Beijing’s incentive schemes, the local governments were compelled to make investment choices that turned out to be sub-optimal in the long term. This leads to the second lesson: States should pursue sustainable economic policies. Short-term gains on high economic output like employment and revenue from infrastructure are not converting into long-term sustainable benefits. Debt-driven growth is not sustainable. None other than citizens pay the price for unsustainable, aggressive growth policies. They face negative externalities like spending cuts, getting ripped off the social safety nets, and reduced disposable income. This leads to the third lesson: Overproduction of physical infrastructure is not economically and socially desirable. Excess supply leads to the problem of ghost cities and unemployment. Fourth, a state should not export its bad economic policies to the rest of the world. China has exported its model of over-investment to other economies like Sri Lanka and Zambia through its debt-trap policy. For instance, Zambia has been overburdened with excessive debt backed by stringent conditions, along with making them centralized, reducing information dissemination, and encouraging corruption in Zambia[5]. The final lesson is on the political economy of economic policies. There is a need to inculcate a democratic economic system in China. The economic system should allow all stakeholders to participate in decision-making across the verticals of the state. Centralization of economic power and policymaking, along with over-ambitious growth plans and antagonism toward people’s voice and activism, leads to an exclusive and unsustainable style of growth, which is growth sans development.

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