China’s Communist Party Debt Crisis: As local Governments use financial instrument issue bond,debt default crisis sets in

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On December 9, 2020, the CPC Ministry of Finance formulated the Measures for the Administration of the Issuance of Local Government Bonds (hereinafter referred to as the “Measures”), which shall come into force on January 1, 2021. Key points are

The local governments shall, according to law, organize the issuance of local government bonds and the repayment of principals and interests of local governments at their own discretion. The issuance and redemption of local government bonds shall be handled by the public finance departments of local governments. The local public finance department shall effectively perform the debt repayment liability, timely pay the principal and interest of bonds, and maintain the government reputation

2. The local financial department shall reasonably determine the bond maturity structure on the basis of such factors as the project term, financing costs, distribution of maturing debts, demands of investors, and the status of the bond market

3.Local public finance departments shall, in accordance with the relevant provisions of the Ministry of Finance, actively issue local government bonds through over-the-counter (OTC) market of commercial banks, continuously expand the channels for issuing local government bonds, and facilitate the investment choices for individuals and non-financial institutions [1].

Local government debt is a very serious problem in the local economy and the biggest financial bubble of the Chinese Communist Party’s economy. It is estimated that many local governments will enter de facto bankruptcy in 2021.

From January to November 2020, local government bonds were issued nationwide, totaling 6.2602 trillion yuan. In particular, 2.2305 billion yuan in general bonds and 4.0297 billion yuan in special bonds were issued; According to the purpose of use, 4.4945 trillion yuan in new bonds and 1.7657 trillion yuan in refinancing bonds were issued [3]. In particular, general bonds shall be used for maintaining the normal operation of the government as a general rule, and special bonds shall be used for local infrastructure construction, among others. The former is used to make up the deficit by borrowing the old and the latter is used for local construction and development. And since when the bonds mature, to borrow and repay the old, the real use is the 4,494.5 billion new bonds [4].

The Ministry of Finance’s delegating authority to local governments to issue debt is a new change. Previously, local government bonds were issued by the Ministry of Finance for the local government, and the money was lent back to the local government. Therefore, the Ministry of Finance must, in the order of “first come, then serve”, issue bonds in order of over 30 provinces, and in some places in time, the people are not too anxious, and some are very apprehensive. Now, the Treasury does not do this burdensome work, hands over authority to local governments to issue bonds and borrow their own money. The Local government issues bonds early and pays higher interest if it needs funds urgently; If they don’t need the funds, they issue bonds later and pay a lower interest rate. The local government decides for themselves

Each year, the National People’s Congress approves the total local debt of the country for the next year, for example, the quota approved in 2019 is approximately 25.8 trillion [2], and then the Ministry of Finance allocates the total bond according to the total debt. Some local governments have good economic conditions and are close to the top decision makers, and if they are not, they have a smaller share, which is how the central government controls local government finances. This is the way the total local bonds are allocated. Because of the approval of the National People’s Congress and the control of the Ministry of Finance, even if this part of local debt defaults, the central government will find a way to solve it and help local governments to pay the bills. As a result, these $25.8 trillion in bonds, which are largely secured by credit, are not highly risky.

The crux of the problem is hidden debt, that is, the part of debt that the local government has not notified the central government and quietly borrowed without endorsement by the Ministry of Finance. Although the local economy is related to the official career of the officials, the original budget law stipulates that the local budget at all levels is prepared according to the principle of income and expenditure, and the deficit is not included [5]. That is, only the money that can be spent can be listed in the budget, and debts cannot be included in the budget. That is, only the money that can be spent is listed in the budget, and the debt cannot be included in the budget. Under the red line, the original officials at that time, even if they borrowed, the amount will be large to affect their careers.

After the global financial crisis in 2008, Wen Jiabao launched a $4 trillion economic stimulus package. This is an unprecedented sum, equivalent to 80% of the central government’s annual fiscal revenue in 2007. At the same time, it was 3.5 times that of the US$168 billion America economic stimulus package that year. In fact, the central government does not have so much money, so propose to provincial governments to contribute at a ratio 1:1. Provincial governments are still disconsolate, and the Wen government puts forward a solution. Since local governments cannot borrow money, local state-owned enterprises will step in  to set up  financing platforms, through which they can borrow and then transfer them to local governments. This is equivalent to releasing an economic monster, which is equivalent to the invalidation of the original budget law, and the amount of debt has also bypassed the approval of the National People’s Congress and the approval of the Ministry of Finance. Local governments cheered and competed to borrow money. That is to say, the rise of local financing platforms is synchronized with the investment plan of the Communist Party of China to deal with the economic crisis.

This amounts to the allowing debt to escalate to an uncontrollable scale similar to a release of an economic monster, equivalent to the failure of implementing the fiscal budgeting rule, and the amount of debt borrowed bypasses the approval of the National People’s Congress and the Ministry of Finance. Amidst the cheers of local governments, they competed to borrow money. In other words, the rise of local financing tools coincides with the CCP’s investment plan to deal with the economic crisis.

Local governments, for the sake of their political achievements, build large-scale infrastructure regardless of cost. If the mayor during his tenure find ways to borrow through local financing platforms, to make the city looks glamorous, he does care how much money borrowed and the consequences in the long run?

As long as he gets affirmation from his superiors, his promotion is one step higher.

By that time, the next government to find a way to continue to borrow new bond to pay off old debt, and continue to conceal. Knowing that local financial resources are unable to pay off all kinds of debts, drinking poison to quench thirst for their own career advancement is happening everywhere.

In 2014, it had a premonition that the huge amount of bad local debt was a problem that would lead to social unrest, so the State Council of the Communist Party of China published the Opinions of the State Council on Strengthening the Management of Local Government Debts, referred to as document 43 [6]. It is stipulated that 2015, local governments can only raise funds in the form of bonds, and the hidden debts of existing local governments will be converted to formal bonds until 2017. Document 43 is equivalent to the central Treasury abandoning the requirements of the original prudent fiscal budget rule requirements. In exchange the local governments are allowed to raise debt and the same time require them to put all the hidden debts on the table so that financial risk is within arm’s length.

But this matter has not been completely resolved, because many debts were not legally processed and were not registered. This part of the hidden debt has been expanding. Moreover, local government officials have enormous and largely unspoken rights because of political dictatorship. The mayor asked to borrow money, and no one dared to object, and later it grew into a loan, and there was no intention of paying it back.

As of the end of 2020, many LGFVs’ ( local government financial vehicle) debts were falling due, and the LGFVs’ money had already been withdrawn by local governments. Unlike the $25,800bn of debt that the central government has approved, LGFV debt is not underwritten by the central government, but local governments are also unable to pay back it. If money not, return, the debt default in the bond market and LGFV will be massive and in lightning speed  

In 2018, according to financial officials of the Communist Party of China, the debt of state-owned enterprises of the Communist Party of China was about 95 trillion yuan (RMB is about 0.158 US dollars), and the debt of local governments is also close to 40 trillion yuan. The above-mentioned local debt of the Communist Party of China of 40 trillion yuan refers to “declared debt”, not including, for example, the “hidden debt” of local financing platform debt. It is not clear how much “hidden debt” of local governments is currently known. Liu Shijin, deputy director of the Economic Committee of the Chinese People’s Political Consultative Conference, said in a previous speech, “From the places investigated, it is at least no less than ‘declared debt’, and some of them are three times higher” [7].

In the second half of 2020, a massive of local financial default occurred as a result of the excessive use of financial leverage in 2008. Financial refugees who have made appeals to rights defenders have been detained, threatened, and no one has ever made a grievance, because local governments are the originators. They won’t solve the problems, they’ll just eliminate the person who raises the problem

On the other hand, because of the government’s low creditworthiness, a sustained financial default could also affect the government’s issuance of bonds in 2021. Even with higher interest rates, few would be willing to buy bonds again, and without enough financing, some local governments would collapse in 2021.

At this time, the “Measures” were issued to let local governments find ways to solve funding and overcome financial difficulties. The solution to the problem is to pay off the debts that are due and rebuild credit rating. However, when the hidden debt has more than three times the explicit debts, and there are still a large number of hidden debts that cannot be clarified, not only the local government unable to pay, but also the central government is unable to repay it. The “Measures”directive is for the central government to tell the local governmentthat they solve their own debt , and the central government is unable to cover it. Is it still necessary to continue to issue new bonds? Whether it works or not remains to be seen.

Reference link:

[1] Notice on Printing and Distributing the Measures for the Administration of Local Government Bond Issuance

[2] Special Research | Local Debt Management to a New Level-A Brief Comment on the Measures for the Administration of Local Government Bond Issuance

[3] Ministry of Finance: the national local government debt balance of 25559.5 billion yuan as of the end of November

[4] China responds to the new policy of economic downturn: large-scale tariff reduction, decentralized local debt issuance

[5] Standardize government fiscal behavior to ensure the healthy development of government debt

[6] Opinions of the State Council on Strengthening Local Government Debt Management

[7] Senior officials of the People’s Bank of China bombarded the Ministry of Finance, Wen Jiabao rescued the market with 4 trillion yuan for ten years.

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