Reform to ease debt risks

With weaker growth in their nominal GDP and a fast slowdown in their tax revenues and land-transferring fees, local governments are seeing their land-related incomes falling daily. The land-related net incomes earned by the local governments in 2012 made up just 20 percent of their financial revenues that year, 31.7 percent lower than the peak level attained in 2010. Although local government debt risks have not yet spiraled out of control, the slowdown of the growth of the national economy as a whole is driving local government debts to an even higher level. Since the Chinese government no longer boasts a financial surplus and a low debt ratio as it did before the outbreak of the global financial crisis, it does not hold a solid position against the risks arising from the rapid growth of government debts, especially as the economy is slowing. It can no longer grow its balance sheet based mainly on land finance any longer.

It is obvious, therefore, that the debt risks endangering both the central and the local governments are rooted in the country's financial system. As the situation stands, it is necessary to speed up reforms of both the central and the local financial systems and substantially increase the financial and debt transparency. Given the fact that repayment of local government debts has entered a peak period, a financial risk reserve should be created and increased year by year. This general reserve fund should be used exclusively for repayment of government debts. This is the most effective arrangement for preventing the spread and transfer of debt risks.

From a medium and long-term point of view, a race between reform and crisis will be inevitable. China must perfect its central and local financial systems, and create a framework for the control of financial debt as soon as possible. Greater efforts are needed to control local government debts by putting into place a budget-regulated debt financing mechanism, so that the debt level of local governments will be kept at a rational level.

The slowdown of the growth of the Chinese economy and the contraction of land-related revenues will put an ever greater debt repayment pressure on the local governments. As the situation now stands, it is necessary to cope with the debt risks by preventing them and lightening them. This brooks no delay in establishing a rational division of financial powers and authority of office between the central and the local governments, and a reform of the country's financial and tax systems that centers on setting responsibilities over spending.

The author is the deputy director and associate research fellow of World Economy Study at the Economic Forecast Department of the State Information Center. www.chinausfocus.com

(China Daily 05/31/2013 page8)