China’s local debt interest hits record high, analysis: solving the dilemma of one trillion national debt is difficult.

The Chinese authorities have revealed that by the end of September, local government debt exceeded 40 trillion yuan (RMB), with interest expenses hitting a new high. Further analysis indicates that by the end of 2023, including hidden debts, local government debt interest amounted to a staggering 3.8 trillion yuan.

To address the debt crisis, it is reported that the Chinese People’s Congress is expected to approve the issuance of an additional 1 trillion yuan in sovereign bonds next week. However, experts believe that this move may not have a significant impact on boosting economic efficiency. They suggest that protecting private economy and instituting political system reforms are essential to achieve the desired effects.

The financial problems of local Chinese governments remain unresolved, relying heavily on issuing bonds to raise funds while also taking on new debts to repay old ones.

The Chinese Ministry of Finance disclosed on Tuesday (October 29th) that by the end of September this year, local government debt had increased to around 44.74 trillion yuan, with interest payments amounting to about 1.04 trillion yuan. This marks the first time in recent years that interest payments on local government debt in the first three quarters surpassed 1 trillion yuan.

Interest payments on Chinese local government debt accounted for about 4.5% of general fiscal expenditures, higher than the 4.1% figure from the same period last year.

According to data from the Ministry of Finance, from 2020 to 2023, visible debt interest as a percentage of general fiscal expenditure escalated to 2.4%, 2.9%, 3.4%, and 3.7% respectively, indicating a notable increase in pressure on local government interest payments.

It’s worth noting that the Ministry of Finance’s local government debt interest only includes visible debts, excluding hidden debts like local government investment debts.

So, how much are the scale and interest payments for local government hidden debts? Let’s take the end of 2023 as an example for calculation.

According to data from the Ministry of Finance, the scale of local government debt at the end of 2023 was 40.74 trillion yuan, with interest payments totaling 1.23 trillion yuan.

Reported by 21st Century Business Herald, at the end of 2023, the scale of interest-bearing debts in local investment and construction projects was around 48 trillion yuan, with an average financing cost of 5.28%.

Calculations reveal that local governments need to pay 2.53 trillion yuan in interest on hidden debts. This means that in 2023, interest on hidden debts was 2.01 times that of visible debt interests, totaling up to 3.8 trillion yuan.

Based on the interest payments on visible debts ratio of 3.7% to general fiscal expenditures at the end of 2023, interest payments on hidden debts accounted for a significant 7.44%, bringing the total to a substantial 11.14%.

The proportion of net interest payments to total tax revenue is an important indicator of sovereign debt risk. Moody’s downgrade from Aaa to Aa usually acts as a caution line around 10%.

Calculations based on fiscal expenditure data show that due to local government fiscal deficits, the results are likely to exceed 11.14% compared to using fiscal tax revenue data.

Following Moody’s debt risk rating standard, local government debt has already crossed the 10% caution line.

To tackle the local debt risks, particularly those related to hidden debts, a plan to approve the issuance of an additional 1 trillion yuan in sovereign bonds is on the agenda for the upcoming National People’s Congress.

According to Reuters sources, the Standing Committee of the National People’s Congress is expected to approve the issuance of at least an additional 1 trillion yuan in sovereign bonds next week. Six hundred billion yuan will be used by local governments to address off-balance sheet debt risks, while the remaining 400 billion yuan will be for real estate companies to purchase idle land and properties.

However, the news of the 1 trillion yuan issuance plan did not boost the Chinese stock market; on Wednesday, the Chinese stock market fell around 0.5%, which also had a negative impact on other Asian markets. Economists believe that this stimulus plan is more likely to stabilize the market rather than prompt economic growth.

Christopher Beddor, the Deputy Director of China Research at Gavekal Dragonomics, mentioned to Reuters on Wednesday that this stimulus plan appears to be primarily aimed at supporting (local government) balance sheets, rather than stimulating immediate GDP growth.

According to a report by China Times in July 2023, it is estimated that the interest-bearing debt of national urban investment and construction companies has reached nearly 60 trillion yuan, with approximately 25% in bond form and 75% in non-bond form.

The International Monetary Fund calculates that by the end of 2023, visible local government debt accounted for 31% of GDP, debt from financing tools (urban investment platforms, etc.) would make up 48% of GDP, and other government-related debt would represent 13% of GDP.

Reuters explains that China’s current issues stem from the excesses of previous stimuli, and the potential effects of the latest stimulus measures on short-term and long-term economic growth remain uncertain.

Gary Ng, a Senior Economist at Natixis in Hong Kong, believes, “This plan may only be a palliative rather than an economic booster. The economic impact may not be as significant as it seems on the surface.”

Local debt and local finance are two sides of the same problem. When local finance improves, the debt issues are naturally resolved.

Regarding local fiscal problems, Xu Chenggang, a Senior Research Fellow at the China Economic and Political Reform Center at Stanford University, expressed in an interview with Deutsche Welle, “There is no short-term solution to the problem, mainly because it is rooted in the system. Any other methods would only mitigate the symptoms temporarily without addressing the root cause.”

Xu Chenggang believes that, “To address its root cause, the first step is judicial independence. In fact, the current economic decline in China is mainly due to the severe damage inflicted by the Communist Party on entrepreneurs’ confidence, as their private property is not adequately protected.”

Furthermore, on this basis, a massive privatization is necessary. “If the government needs money, it can sell assets to generate income. By selling assets, assets sold by the Communist Party would enter the private sector, and with restored confidence in the private economy, economic recovery is possible.”

Referring to insufficient domestic demand, Xu Chenggang emphasized that this is a common characteristic of authoritarian regimes. The Chinese Communist Party has taken away a significant portion of earnings generated through economic development, using mechanisms such as land and banks.

However, Xu Chenggang believes that boosting consumption cannot be achieved solely through structural economic reforms; instead, it requires reforms in the political system.

He stated, “In any part of the world that aims to solve the problem of insufficient domestic demand, to prevent household income from comprising as low a proportion of GDP as it does in China, privatization is essential.”