Local gov't debts sound warning
While China's fiscal revenues have given officials reason to smile, local governments' debts have given them some cause for concern.
Those debts - nobody knows exactly how huge they are - threaten the country.
"Without an effective solution, the local governments' debts will harm our fiscal stability, and the central government's credit," said Wei Jianing, deputy director of the Macroeconomic Research Department under the State Council's Development Research Centre.
He made the remarks last month after Finance Minister Jin Renqing told the second plenary meeting of the 10th National People's Congress (NPC), China's legislature, that government's revenues for the entire country were 2.17 trillion yuan (US$262.1 billion) last year.
That was up 14.7 per cent over the previous year.
Unlike the central government, local governments are teetering on financial chaos. No one can accurately tally those governments' combined debt.
A report presented by Li Jinhua, head of China's National Audit Office, to the NPC's standing committee last June, indicated the combined debt of 49 cities and counties in 10 central and western provinces reached 16.3 billion yuan (US$1.97 billion) at the end of 2001.
That was 2.1 times the communities' disposable financial revenues for that year.
Jia Kang, director of the Institute of Finance under the Ministry of Finance, said a nationwide inspection in 2001 discovered township governments' combined debt was roughly 370 billion yuan (US$44.69 billion).
"That was only a preliminary estimate. The actual situation might be more serious," Jia said late last month during a seminar on local governments debt.
Wei said recorded debts are only part of local governments' liabilities. The arrears also include unpaid construction bills for infrastructure, guarantees for loans and some corrupt officials' personal debts.
While community governments throughout the world have long been coping with debt, the situation in China can be traced to 1994.
That year, the central government implemented tax reform that divided the taxation system into State taxation and local taxation.
Most of the stable, high-revenue taxes - such as value-added taxes - were collected by the central and provincial governments. Low-revenue taxes - such as agricultural taxes - were left to local governments.
The central government in 2002 collected 54.9 per cent of China's total tax revenues; provincial governments, 28.8 per cent; and local governments, 16.3 per cent.
Some 1.89 trillion yuan (US$228.26 billion) in taxes were collected in 2002 by the three levels of governments.
Before the tax reform, local governments' revenues accounted for more than 50 per cent of China's total tax income.
"Despite their dwindling revenues, local governments were still responsible for infrastructure construction, education and social insurance," Li Jianhua, a senior researcher with the Research Development Centre, told China Business Weekly.
Li is a member of a research team, being led by Wei, that is studying local governments' debts.
After the Chinese Government centralized national revenues, it implemented transfer payments to local governments to offset their lost tax revenues.
The central government last year issued 448.9 billion yuan (US$54.2 billion) in transfer payments to local governments.
The transfer payments accounted for 54.2 per cent of the central government's fiscal revenues last year, which hit 1.25 trillion yuan (US$150.5 billion).
Those payments, however, cannot meet local governments' spending obligations.
Local governments in recent years have launched infrastructure projects - including building highways, subways and airports.
Massive government spending to spur economic growth, which has been a major initiative in China under the current economy, has worsened the situation facing local governments.
Instead of simply being a public administrator, China's local governments must become investors and managers of State-owned enterprises within their jurisdictions, Li said.
Local government, despite legal restrictions, have not become fiscally prudent.
Under China's Budget Law, which was adopted in 1994, local governments must be cautious when adopting and implementing spending policies.
It is illegal for local governments to have operating deficits, except in extenuating circumstances approved by the State Council, the nation's cabinet.
That is in theory.
"Without borrowing money, local governments cannot finish their infrastructure projects or finance business investments," said Liang Peng, a professor of economics with the Central Party School.
Local governments' officials are afraid, given the Budget Law, to borrow money publicly, Wei said. As a result, they generally borrow money secretly, and occasionally through illegal channels.
Subsequently, it is impossible to tally the combined debt of China's local governments, Wei added.
China's government system worsens the problem.
In China, leaders of the local governments are not responsible for the money they have borrowed, on behalf of the community, after they leave office.
As a result, many leaders borrow massive amounts of money and spend heavily on projects without thinking, or worrying, about how to repay the loans.
Redundancies in the governments and corruption have combined to increase local governments' debts, Liang said.
The local governments' heavy debts are causes for worry, especially as community leaders search for ways to repay the loans.
In theory, it is not a problem, given the fast growth of China's fiscal revenues. In practice, however, the situation has become a nightmare for the local governments, especially those in poor regions, Liang said.
Some of the local governments also owe large amounts of money to overseas investors. Those debts are also hard to calculate.
Local governments' overseas debts will not affect China's ability to borrow and repay money because the central government has access to large amounts of money, Liang said.
A larger, more serious threat looms in China's financial sector.
At least 100 billion yuan (US$12.1 billion) in bad bank loans have either been issued to or guaranteed by local governments annually since the mid-1990s, Wei said.
Local governments' inability to repay those loans threatens the stability of China's financial sector, Wei said.
More important, such financial liabilities distort local governments' behaviour, Liang said.
The local governments should have been public administrators; now, they must find revenues to repay their debts. That means they must invest in profitable businesses to earn revenues. But many governments' investments in competitive fields have failed, which has resulted in greater government debt.
As a result of their debts, local governments have used their transfer payments to invest in profitable ventures, which has left education and health care underfunded.
Some local governments have imposed various fees on local enterprises and farmers to increase revenues.
The more local economies suffer, the more local governments try to increase revenues through unreasonable, or even illegal, levies, Li said.
"This leads to corruption, and a poor image of local governments," Li said.
Scholars have proposed various solutions, but they will not be easy to implement.
Wei, for example, proposes the Budget Law be revised to allow local governments to issue bonds.
"Combined with other measures, like clearly defining local governments' liabilities and stipulating punishments ... this will ensure governments' hidden debts become transparent and that governments follow procedures when borrowing money," Wei said.
If local governments are coping with deficits and insufficient revenues, how will they be able to repay the bonds' investors?
"The bonds will have to be issued in richer regions, in which the local governments have better revenues," Li said.
Bonds will not erase the debts of local governments in China's hinterland, which is poor, as the communities are dependent on transfer payments from the central government.
In addition to 427.7 billion yuan (US$51.5 billion) in tax rebates and structural subsidies, the central government plans to grant local governments 513.3 billion yuan (US$61.8 billion) in transfer payments this year, up 64.4 billion yuan (US$7.8 billion) over last year, Jin said.
"That is not enough, as local governments' thirst for capital is unbounded," Li said.
"A basic solution is to cut local spending, such as investments in competitive industrial sectors."
The number of local governments' employees must be cut, and people's congresses at the local level must closely scrutinize the governments' spending, Li suggested.
Zhang Hong'an, a senior official with the Ministry of Finance's budget department, said the central government has long been aware of the situation.
"Scholars' research and suggestions will be helpful as we draft policies. But a policy cannot be made cursively," Zhang told China Business Weekly.
The Ministry of Finance is conducting a massive investigation to identify all of the local governments' debts, Zhang said.
The ministry is also trying to develop a scientific evaluation system to determine the safe level of debt for local governments.
"There is no legal barrier to local governments issuing bonds, as the Budget Law stipulates local governments can have deficits in extenuating circumstances," Zhang said.
"But it is not simply an economic issue; rather, it is political, as the issuance of bonds might result in greater decentralization," Zhang added.
Therefore, any measure to solve local governments' debts must be implemented
with care, and must be based on accurate statistics, the official