China is under increasing pressure to ramp up its fiscal spending as worries mount over slowing economic growth and rising local government debt. At recent meetings in Bangkok, the International Monetary Fund (IMF) pushed Beijing to introduce more substantial fiscal stimulus to counter deflationary pressures. The IMF forecasts that China's economic growth will slow to 4.5% this year, down from 5% last year, with a further decline to 4% expected by 2027.
Despite China's capacity to borrow, with its general government debt at about 68.4% of GDP, local governments are wrestling with a debt crisis. Last year, the total government debt, including local government financing vehicles and off-balance-sheet borrowing, shot up to approximately 126.6% of GDP. This level is akin to the debt burdens seen in developed markets like the U. S. and Europe.
Traditionally, local governments in China have depended on selling land to developers to finance infrastructure projects such as roads and railways. But this revenue stream has plummeted since the property market downturn began in 2021. Income from land sales has more than halved, dropping from 8.7 trillion yuan in 2021 to 4.2 trillion yuan, or about $590 billion.
The drop in revenue has resulted in decreased fiscal spending. Ting Lu, Nomura's chief China economist, estimates that combined fiscal spending fell by 3.5% in the first eight months of this year, following a 3.6% increase the previous year. Lu calls this a "true fiscal cliff" dragging down the economy. Urban fixed-asset investment, a crucial growth driver, also fell, declining 3.8% last year and 7.2% in the first three quarters of this year.
Beijing has kept its official deficit target around 4% of GDP. Yet, the Institute of International Finance estimates the actual deficit could reach as high as 9%, which might still fall short of addressing the economic challenges. In response, Beijing has instructed state-backed borrowers to eliminate hidden debt and transition into market-oriented commercial state-owned enterprises by mid-2027.
S&P Global Ratings indicates that hidden debt in local government financing vehicles decreased from 14.3 trillion yuan to 6.5 trillion yuan ($973.3 billion) last year. Despite this reduction, many of these vehicles continue to face cash flow issues and are burdened with unprofitable public projects.
The IMF advises China to adopt a medium-term fiscal framework to balance short-term economic reflation with long-term debt sustainability. The IMF also suggests China move away from rigid growth targets that drive local officials toward excessive investment.
The stakes are high. Allowing any local government to default could set a dangerous precedent. Logan Wright, a partner at Rhodium Group, noted that no local official wants to be the first to default. However, once one defaults and Beijing intervenes, others may expect similar bailouts, potentially leading to conflicting priorities between local and central government officials.
Upcoming events include the Chinese Communist Party's fifth plenary meeting from October 26 to 29, the release of China's official manufacturing PMI for October on October 31, and the RatingDog manufacturing PMI for October on November 2.
