China's debt-relief package, a pivotal step for economic stability, progress

BEIJING -- Just as a single decisive move can energize a chess game, China's latest initiative to address local government debt risks marks a crucial step in revitalizing the growth prospects of the world's second-largest economy.

The move comes as China gears up to navigate economic headwinds both at home and abroad, with a supportive fiscal policy serving as a crucial pillar to sustain a steady and robust recovery.

Local governments, the linchpins of the country's fiscal outlays, were stuck in a dilemma of high debts and falling revenues, bringing challenges to the efforts of bolstering the economy. With the debt-relief package, a well-timed financial adjustment to ease local governments' financing strains, the country is better positioned to pursue the broader agenda of fostering economic stability and progress.

CRITICAL MOVE

Unveiled in November, the debt-relief package is "the most significant measure introduced in recent years" to tackle the challenges, according to Finance Minister Lan Fo'an.

It includes raising the debt ceiling of local governments by 6 trillion yuan ($834.36 billion) over the next three years to replace the existing "hidden debts," a form of off-budget borrowings through local government financing platforms, government investment funds, and other channels.

As of Wednesday, 29 provincial-level regions, including Beijing, Jiangsu and Guizhou, had issued or disclosed plans for refinancing bonds, meeting this year's issuance target of 2 trillion yuan.

Additionally, local governments are allowed to use 800 billion yuan annually in special-purpose bond issuance for the five consecutive years starting from 2024, aimed at providing debt relief to replace "hidden debts."

Officials estimate that swapping the off-budget debts for on-budget is expected to save 600 billion yuan in interest for local governments over five years.

The Ministry of Finance has confirmed that at the end of 2023, the "hidden debts" stood at 14.3 trillion yuan, which authorities aim to address by the end of 2028.

Under the new arrangements, some 2 trillion yuan of "hidden debts" accumulated from housing improvement projects in run-down areas due by 2029 and beyond will also be paid in accordance with the original contracts.

Analysts believe the debt swap program will unclog capital flow to the real economy and help sustain the momentum of the economic recovery.

With the debt-relief package, the total hidden debts that local governments need to address by the end of 2028 will be cut from 14.3 trillion yuan to 2.3 trillion yuan. This can free up financial resources and policy space for local governments to promote development, improve people's well-being, boost investment and consumption, and support technological innovation, according to Lan.

CHANGING APPROACH

Besides its unprecedented scale, the package reflects a fundamental shift in China's approach to resolving local government debt risks, according to analysts.

Unlike the country's earlier efforts to resolve debt risks, the latest initiative reflects a shift from reactive crisis management to proactive and systemic resolution, and a transition from dual-track oversight of explicit and implicit debts to transparent and standardized management of all debts, said Fan Ruoying, a researcher at Bank of China.

It also indicates the central authority's guiding thoughts of defusing debt risks through development while trading time for development space, and illustrates the government's determination to promote economic growth while mitigating local government debt risks, said Luo Zhiheng, chief economist at Yuekai Securities.

Under the new arrangements, local governments still bear the debt repayment responsibility, but swapping to on-budget debts, with longer repayment periods and lower interests, can help ease the pressure on them to repay short-term debts. Effective debt swaps allow local governments to have more funds and space to promote economic growth and ensure people's livelihoods.

Lan said the finance ministry, together with relevant departments, will maintain a "zero tolerance" stance on increases of new hidden debts, further improve the local government debt management, and accelerate the establishment of a debt system with Chinese characteristics in line with the country's high-quality development.

The third plenary session of the 20th Communist Party of China Central Committee, held in July, made arrangements concerning the issue, which include improving the government debt management system, establishing a system for monitoring and regulating all local government debt as well as long-term mechanisms for preventing and defusing hidden debt risks, and moving faster to reform and transform local government financing platforms.

STRONGER POLICY SUPPORT

The expedited implementation of the debt-relief package indicates that China is enhancing the intensity of its proactive fiscal policy, and the country still has a relatively large space for fiscal policy maneuvering, with its government debt level far lower than that of other major economies, according to officials and economists.

By the end of 2023, the average government debt-to-GDP ratio for G20 countries was 118.2 percent, while the average debt-to-GDP ratio for G7 countries stood at 123.4 percent, according to data from the International Monetary Fund.

In contrast, China's total government debt was 85 trillion yuan by the end of 2023, resulting in a government debt ratio of 67.5 percent.

The country has set its deficit-to-GDP ratio at 3 percent for 2024, which means 4.06 trillion yuan in government deficit, an increase of 180 billion yuan over the 2023 budget figure, according to this year's government work report.

China has vowed to implement a more proactive fiscal policy in 2025, set a higher deficit-to-GDP ratio and ensure that its fiscal policy is continuously forceful and more impactful, according to last week's tone-setting meeting, the Central Economic Work Conference.

Next year, China will actively use the room for a higher deficit, increase the issuance of local government special-purpose bonds, continue to issue ultra-long special treasury bonds, and increase transfer payments from the central government to local governments, said Lan last month.