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Sunday, April 14, 2024

China’s Debt Crisis: The End of the Road for “Extend and Pretend”?

The ‘basket of measures’ Beijing promised to defuse local government debt risks is likely to include special bond issuance, debt swaps, loan rollovers, and something it loathes: dipping into the central budget. But how much of a help these are will be a crucial test of how decisive and long-lasting a solution Beijing can deliver.

The central government is stepping in to limit the impact of local debt risks on economic growth after years of over-investment in infrastructure and plummeting returns from land sales. Local authorities borrowed heavily to meet ambitious growth targets and invest in projects vital to China’s national development strategy, such as transport infrastructure, energy, ecological conservation, and government-subsidized housing.

But the resulting debt overhang is a direct threat to economic progress. It also undermines Beijing’s ability to control prices and protect workers from soaring coronavirus costs. And it suffocates the government’s ability to push growth, stabilize employment and expand public services.

According to the International Monetary Fund, local governments’ debt rose to 92 trillion yuan ($12.8 trillion) in 2022, which estimates that it could rise further this year. That’s nearly three times more than their tax revenues and significantly affects China’s economic performance, making it one of the world’s slowest-growing economies.

To address the issue, Beijing has shifted from insisting on “strict control” of local debt to urging them to take responsibility and speed up their efforts to restructure their financial models. It has also warned that the central government will no longer bail them out.

That will require a significant overhaul of local debt financing, including limiting the money raised through bonds and requiring all projects to get state approval before getting underway. It also means rethinking how local governments allocate funding to projects and focusing on high-impact ones rather than those with little or no economic benefits. And it will mean putting the brakes on lending to local governments to reduce speculative investments and risk-taking.

In a sign that the rethink is beginning to take shape, 31 provinces have revealed their advance-approved quota for new special bonds and general debt this year, up from around 50% last year. But the rebalancing will only be complete when Beijing eases restrictions on the types of projects that can be financed by these bonds and lifts arbitrary limits on bidding to encourage trading.

China is also considering letting local governments use the proceeds of a unique bond-based mechanism to pay for carbon credits to offset their emissions, a source familiar with the matter told Reuters. That could be a first step toward an eventual system allowing investors to invest in conservation practices backed by environmental credit rating agencies. The big ‘if’ is whether this will lure private capital, particularly from abroad, as investors have so far been wary of investing in carbon finance projects in the past.

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