An Assessment of China’s New Phase of Hidden Debt Risk Prevention and Resolution

China’s Ministry of Finance has recently announced a number of irregularity cases in the resolution of local hidden debt, and said that it will continue to strengthen supervision with relevant departments. It also pledged to conduct serious investigation on this matter, as well as deal with new hidden debt, false settlement of hidden debt, and other illegal acts. The ministry urged relevant local governments and departments to earnestly carry out accountability work to form an effective deterrent.

As the COVID-19 pandemic lingers on, local governments face increasing fiscal pressure and great challenges. the Ministry of Finance’s announcement of irregularity cases in the resolution of hidden debt further strengthens the policy red line of local hidden debt issue and restricts local construction investment and financing. In the view of ANBOUND, the underlying policy intention is clear. The policy red line remains a deterrent even as local infrastructure investment is expanded, where government financing is promoted to ease the pressure on fiscal spending.

Researchers at ANBOUND have repeatedly alarmed local governments of the possible consequences of blind financing. At present, the functions of local financing platforms are essentially halted, and this will put more pressure on regions with a heavy debt burden.

The eight typical cases of hidden debt accountability reported by the Ministry of Finance include: 1. False settlement of hidden debt and new hidden debt of Anqing, Anhui Province. 2. Shihe District, Xinyang, Henan Province added hidden debts under the guise of hospital procurement of drugs. 3. Xingyi, Guizhou Province increased its hidden debt by financing through state-owned enterprises. 4. Guixi, Jiangxi Province raised funds through a financing platform company for municipal construction expenses and added hidden debts. 5. False settlement of hidden debt and new hidden debt of Ningxiang, Hunan Province. 6. Mengzhou, Henan Province added hidden debts in the name of government purchase of services. 7. Huzhou Economic & Technological Development Zone in Huzhou, Zhejiang Province added hidden debts by way of appropriating funds of state-owned enterprises. 8. Qilihe District, Lanzhou, Gansu Province, defaulted on public welfare projects and led to the new hidden debt. According to the Ministry of Finance, the above eight typical cases reflect that some local government units failed to implement the decisions and plans of the CPC Central Committee and the State Council, which seriously affected the prevention and resolution of hidden debt risks.

Looking at these specific cases, researchers at ANBOUND have noticed several details. One is the timing. Most of them happened before 2020, and the most important ones are the ones that happened in 2017 and 2018. On the one hand, considering the time and process needed to deal with the relevant issues, it can be assumed that the relevant issues occurred earlier. It is worth noting that there are no cases after the issuance of the “Guiding Opinions for Banking and Insurance Institutions to Further Do a Good Job in Preventing and Resolving Hidden Debt Risks of Local Governments (Circular 15)”. It may be that it takes a process to identify and deal with new issues, but it is more likely that the local hidden debt resolution efforts have entered a new phase.

In such a new phase, the Ministry of Finance announced the existing issues in the form of a briefing, indicating that they need to be resolved in a market-oriented manner, and the practice of local fiscal “bailout” is no longer legitimate. Of course, when local governments are allowed to issue bonds and special bonds, they will be allowed to replace the debts of normal government investment projects. Under the circumstance that the issuance of local government special bonds has gradually become normal and the financing of local government projects has become more open, the hidden debt financing through financing platforms has lost its legitimacy, and the window has begun to close.

In terms of the projects involved in the cases, shantytown renovation, misappropriation of investment funds in the public sector, and false debt settlement reflect that the relevant disciplinary measures have involved government officials at all levels. On the one hand, this reflects the huge hidden debt burden of local governments, many of which are already unsustainable. On the other hand, these projects involve more or less government investment and investment in public utilities, which do have policy overtones, and many irregularities are related to governmental actions. Under pressure, local governments have resorted to irregularities to perpetuate the hidden debt. In the new phase, especially under the impact of the pandemic, local governments are facing increasing fiscal pressure, and the policy focus has shifted to “strictly prohibit new hidden debt”, while there are no new requirements for the resolution of existing debt. In fact, since the release of Circular 15, the central government has repeatedly emphasized the “prohibition of new local hidden debt” in the statement of fiscal policy. Therefore, the announcement of old cases at this time is a warning to local governments to pay attention to “stabilize leverage”. On the one hand, local governments are encouraged to finance infrastructure projects through special bonds. Hidden debt, on the other hand, is strictly prohibited.

In the past, local governments often increased their leverage by issuing special bonds and urban investment bonds to finance investment projects. After the issuance of Circular 15, local governments face a one-way financing mode in which special bonds are encouraged while urban investment bonds are restricted. Local governments can neither rely on new hidden debt to finance local construction, nor take the opportunity to replace the existing hidden debt with new government debt. The hidden debt issue has also been resolved in a prudent way through gradual trials and explorations, without any explicit requirement for fiscal deleveraging.

In the process of resolving hidden debt, ANBOUND believes that while preventing the “disorderly” expansion of local government debt, it is necessary to take into account the current fiscal pressure of local governments and regional credit risks. From the perspective of the current policy focus of the Ministry of Finance, its focus is on “preventing new hidden debt”, while the existing debt mainly maintains the continuity of debt by maintaining the existing scale and combining market-oriented debt. This means that local governments should set priorities when dealing with debt issues. First, new projects should be financed mainly with local government bonds, so as to avoid new government debts from the financing platform. Second, as a financing platform, urban investment enterprises should participate in market-oriented projects and carry out market-oriented transformations. Third, local governments should pay attention to their debt ceiling to avoid falling into a vicious circle. Fourth, the main purpose of resolving existing hidden debt is to maintain the sustainability of debt.

Final analysis conclusion:

China’s Ministry of Finance’s announcement of “old” cases of irregularities in the disposal of hidden debt is mainly to serve as a warning. This once again clarifies the policy red line of hidden debt and also indicates a new phase of hidden debt resolution. In such a new phase, the policy focuses on “strictly prohibiting new hidden debts”, while taking a longer time to resolve the existing hidden debt.

Writer by Wei Hongxu
A researcher at ANBOUND, graduated from the School of Mathematics at Peking University and has a PhD in economics from the University of Birmingham, UK

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ANBOUND is a multinational independent think tank, specializing in public policy research, incl. economy, urban and industry, geopolitical issues. Est. 1993.