As the long-delayed Third Plenum session ended last week, it is far from clear what the Chinese regime’s five-year plan will involve. Beijing seems to think that its earlier efforts to deal with the property crisis are sufficient.
The meeting produced little news on this front. That is unfortunate, for more is needed. It was helpful that the meetings mentioned the need to deal with local government debt, but here, too, the proposed program, if there is one, is distressingly short on details. Without an effective program, this local government debt overhang will hold back Chinese growth even in the unlikely event that the property crisis lifts.
The local government debt problem pivots on what are called local government financing vehicles (LGFVs). For years, planners in Beijing promoted LGFVs to allow local governments to borrow the huge amounts needed to finance Beijing’s infrastructure projects. Because the debt is held in the LGFV instead of on the local government’s balance sheet, the process allowed local government borrowers to avoid statutory and customary debt limits and, in many respects, even public scrutiny. Because the government connection also made lenders much less careful than they otherwise might have been, this off-the-books “shadow debt” has, over the years, grown to huge proportions. At last count, the amounts range from an equivalent of $7 trillion to $11 trillion. This is twice the size of the debt of China’s central government in Beijing.
In many respects, these LGFVs stood behind the huge Chinese infrastructure projects that so awed Western observers over the years—the massive apartment complexes, dazzling provincial city centers, broad highways, bridges, rail links, ports, subways, light rail systems, and the like. The spending and employment involved in these projects boosted China’s growth figures and led the Chinese Communist Party (CCP) to take credit for the growth. And especially early on, the progress was real. But over time, the returns from each new project had less and less ability to support the debt incurred to move it forward. This unsupportable debt now threatens to unravel these former practices.
At the most basic level, the fault for this mess lies with the centralized planning on which the CCP relies and which has directed local government borrowing and spending. Because the projects came out of government decision-making, they tended to reflect political rather than economic priorities. Early on, this distinction mattered little. China’s underdeveloped state made needs obvious. But over time, Beijing’s political preferences had less to do with economic needs and consequently paid a less-than-adequate return.
Estimates that the equivalent of some $800 billion in LGFV debt will never be repaid are in large part why the credit-rating agencies, Fitch and Moody’s, downgraded China’s financial prospects. Local governments are staggering under the weight of these unmanageable obligations. Some are even having difficulty providing their populations with essential services. Meanwhile, Beijing has lost a major source of growth.
If Beijing wants to revive China’s economy, it will need to find a way to remedy this problem. If left unattended, the LGFV problem has the potential to do more harm even than the headline-grabbing property crisis. Even should a plan emerge, likelihoods suggest that it will be inadequate for the task. At least, that is the message of the halting and tentative manner in which Beijing has moved to address the property crisis. Even if the planners prove themselves capable of direct and forceful action on this front, it will take years to straighten out these matters, years in which China will have no way to recapture the pace of growth it once enjoyed, and that is essential to the CCP’s ambitions.
