Budget Law changes to rein in local govt debt

Amendment will boost transparency, increase control

At the end of August, the government approved a draft amendment to the Budget Law after four rounds of review. The passage of the draft amendment is the most important milestone in 20 years for the government's effort to alter the country's economic structure.

Local government debt is one of the biggest challenges to this effort. As it currently stands, the Budget Law prohibits local governments from issuing bonds in their own name. The measure was supposed to prevent local governments from running up huge debts. Unfortunately, it didn't work. Local governments found a work-around. They began creating companies, known as local government financing vehicles, to issue bonds and take out bank loans on their behalf to finance infrastructure and other projects.

These bonds allowed local governments to issue debt while complying with the Budget Law. However, there was a drawback. Issuing debt through these companies disguised the size of the debts, which are considerable. China's national auditor eventually determined that the liable debt balance of local governments was 10.8 trillion yuan ($1.75 trillion) at the end of June 2013.

The draft amendment to the Budget Law aims to make local government debt more transparent and accountable by granting local governments the right to issue bonds on their own. They will also have to report these debts on their budgets.

The most recent data show that the government debt balance of 18 regions in China increased 3.79 percent in the first half of 2014, down 7 percentage points from the same period in 2013.?

A slowdown in debt growth refutes the argument that risks would rise after the new budget law amendment gave the green light to local government to issue bonds. But a deeper comparison between China and Western countries can help explain the controllable nature of local debt in China.?

Unlike developed Western countries where the majority of debts come from consumer credit, China's local government debts are mainly used to finance infrastructure projects, which can bring in a steady flow of profits and provide some security for repayment.

In addition, in the highly free market of a Western country, a mass of social capital is in the hands of privately owned enterprises. In sharp contrast, China's government has control over massive assets.?

By the end of 2012, China's central and local governments held more than 50 trillion yuan in assets from State-owned enterprises and 80 trillion yuan in State-owned financial assets, according to data reported by a subsidiary media outlet supervised by the National Development and Reform Commission (NDRC), China's top economic planner. These figures did not include urban land and rare minerals. In addition, disposable assets accounted for as much as 50 percent of the social balance sheet, according to some media reports.?

Therefore, paying back the local debt would not be out of the question if local governments chose to cash in some of their investments. However, that doesn't mean that local debt is risk-free, especially when tax revenues are on a downward trend due to a cooling property market.?

The central government's top priority should be to change the way it measures economic development. Pursuing staggering GDP growth has forced local governments to spend money in an unrestrained way, but development is surely not limited to figures and data. If the central government separates GDP growth from its assessment of local government performance, local governments will start to lean away from an economic model based on frenzied investment.

All of this would amount to ingenious nonsense, however, if the local debts are not supervised by local and central authorities. Many of the current debt-related problems have emerged from the fact that different local governments employ different statistical standards, which creates loopholes for some debt figures to disappear from the table cell where they're supposed to be.?

Although local governments will have the right to issue debt for necessary investments in public goods, the amount will be closely monitored and tightly controlled by the central government, according to the draft amendment. However, to hedge against any debt risks, local governments are also obliged to establish effective assessment mechanisms to track the safety of debts.

The new amendment of China's Budget Law will go into effect on January 1. It represents remarkable progress.