China reform plan sets scene for local clampdown

TN News

Email Print

Workers labor as cranes operate at the construction site of a power plant at the China Hongqiao Group Ltd. aluminum smelting facility in Zouping, China, on Nov. 4, 2013. Photographer: Brent Lewin/Bloomberg

China's Communist Party signaled a bigger focus on fiscal concerns during President Xi Jinping's tenure, setting the scene for a clampdown to control the finances of indebted regional authorities.

Local governments will be able to sell bonds to fund construction and officials will be rated on measures including borrowing levels, the party said Nov. 15. An easing of the one-child policy and extra land rights for farmers also featured in the biggest package of reforms since at least the 1990s.

Tightening control over local finances and allowing new channels for funding would limit the risk of a debt crisis hobbling the world's second-biggest economy, while corruption arrests since Xi became party chief may signal that officials ignore directives at their peril. The scale of regional debt woes is set to be shown in an audit that the Finance Ministry said was due last month although it has yet to be released.

"It requires a lot of political brute force and it's something you can only achieve if you are extremely vigorous," said Arthur Kroeber, Beijing-based managing director of economic research firm GaveKal Dragonomics, referring to efforts to ensure local governments toe the line. "The localities have so much power and their incentives are so non-aligned with the party's grand objectives that it's a real problem."

Fight corruption

The anti-corruption campaign started by Xi when he took over as party chief last year may be a way of telling officials and state-company bosses, "Look, this is the way it's going to be, and if you don't like it, we have a lot of space in the jails for you," said Kroeber, who is also a fellow at the Brookings-Tsinghua Center for Public Policy in Beijing.

The Hang Seng China Enterprises Index (HSCEI), also known as the H-share index, rose 3.4 percent at 10:07 a.m. in Hong Kong, poised for the highest close since May. The benchmark Shanghai Composite Index (SHCOMP) climbed 0.9 percent, following a 1.7 percent gain on Nov. 15 ahead of the policy package's publication.

A separate statistics-bureau report today showed new home prices in China's four major cities rose last month by the most since January 2011, raising concern that a bubble is forming as a lack of new nationwide property curbs emboldens buyers.

In a Nov. 1 speech on local-government reform, Premier Li Keqiang said some authorities, in their own self-interest, had only paid lip service to changes demanded by the central government, according to a transcript published in the China Daily newspaper. Local authorities must not be allowed to "play tricks or conduct reform as a mere formality," he said.

Decisive role

The fiscal proposals were agreed to at a four-day Communist Party meeting ending Nov. 12 that laid out economic and social reforms for the next decade, with pledges to reduce the state's role in the economy and make markets "decisive" in allocating resources.

Pledges listed in a 60-point document published three days after the meeting, known as the third plenum, included establishing market-determined prices for resources, boosting private-sector and foreign investment, and encouraging urbanization by scaling back the hukou, or household registration system, to allow rural migration to smaller cities.

The party listed fiscal and tax reform as the fifth out of 16 main points in its document, describing finance as a foundation and important pillar of the country's governance and which guarantees long-term stability. Among proposed changes are making budgets more transparent, improving transfer payments, setting up risk-warning and debt-management systems for central and local governments and speeding up legislation on a property tax, according to the document.

Spending, taxes

Currently local governments are responsible for 80 percent of spending while getting about 40 percent of tax revenue, according to the China 2030 report published last year by the World Bank and Development Research Center of the State Council.

"Right now the situation is totally unfair for local governments -- they have to bear most of the burden and they get a small proportion of the tax revenue," said William Overholt, senior fellow at the Harvard University Asia Center in Cambridge, Massachusetts. "Changes to the hukou system would put a bigger burden on city and town governments and with all these social services to offer it would just sink the finances of localities that are already seriously strained."

Fiscal and tax reforms will broaden local governments' sources of income, helping to reduce local fiscal risk "and return local government finances to a more sustainable path," Liu Li-Gang and Zhou Hao, China economists at Australia & New Zealand Banking Group Ltd., wrote in a report yesterday. "At this stage, the local government debt is still manageable as the local governments still own a large amount of assets on their balance sheet."

Rising debt

Liu and Zhou estimate that the audit of local government liabilities ordered by the State Council in July will show total debt of 14 trillion yuan ($2.3 trillion). Liu Yuhui, a researcher at the Chinese Academy of Social Sciences, estimated in September the debt could be as high as 20 trillion yuan.

Both figures would be higher than the end-2010 total of 10.7 trillion yuan given by the National Audit Office in a report published in June 2011, which amounted to 27 percent of gross domestic product. The financing arms of municipal authorities, known as local government financing vehicles, owed banks 9.7 trillion yuan, or 14 percent of all loans in mid-2013, according to figures from the China Banking Regulatory Commission.

Pilot program

China began a trial program in 2011 to let some local governments sell bonds directly and expanded the pilot in June, allowing Shandong and Jiangsu provinces to join Zhejiang and Guangdong plus the cities of Shanghai and Shenzhen. A proposal that would have allowed authorities to sell bonds within an approved quota was dropped from a revision of the budget law in June 2012.

In a further attempt to rein in local debt and push local governments to obey the reform mandates set by the party, officials will be evaluated less on economic growth and more on borrowing levels, welfare improvements, controlling overcapacity and environmental degradation, according to the Nov. 15 party document.

While Xi's officials are trying to limit wasteful outlays and vanity projects, the latest local-government spending to generate public concern is the construction of a giant, metal "puffer fish tower," intended to be a tourist attraction, in one of the nation's most-indebted provinces, Jiangsu.

"If you can get the fiscal arrangements right and give localities enough financial incentives to do the right thing then you have a better chance of succeeding" with reforms, said Kroeber of GaveKal Dragonomics. "If you have these localities that are in hock up to the neck with debts that they can't pay and you are the central government and you want these guys to do something, well, that gives you a certain amount of leverage."

More World News