Land-sale finance can no longer sustain cities

How can China's hard and long-drawn economic transition be judged from what its cities have done to drive local economic growth? The fact is they have basically done nothing in the past three years.

The old practice of funding local development with fiscal revenue from land auctions for housing projects, which people call "land-sale finance", still continues in many cities. There hasn't been a meaningful replacement of the source of local revenue in many cities even though land-sale finance no longer generates as much funds in these times of economic slowdown.

Nurturing new growth industries and building new growth drivers, what the central government has envisaged, is happening in only a few cities. Last year's data show some of the most financially powerful cities continue to rely on land-sale finance for more than half of their revenues, as they did in the years immediately following the 2008 global financial crisis when housing development was a speculative game and housing prices were rising rapidly. Such cities include Nanjing, Hefei, Guangzhou, Fuzhou, Foshan, Haikou, Jinan, Wuhan, Hangzhou, Changzhou and Shijiazhuang.

Industry experts argue that much of their land-sale finance is unhealthy and unsustainable. The practice may cause more harm than good, according to Hu Zhigang, deputy head of China Real Estate Association.

"Flawed incentives" have led to, in some places, the creation of more new housing projects than permitted by real market demand, Hu said. This, in turn, has given rise to "social and environmental problems". The risk of default is on the rise, as a result.

Local governments' dependence on land-sale finance is not a smart move to start with. In 2013, a sample survey by the National Audit Office showed it can cover only about 37 percent of the total debts incurred by the local governments.

Gao Huiqing, an economist with the State Information Center, commenting on the ongoing economic slowdown, said it is difficult for local governments to generate higher income from land sales. It will be even more difficult in cities with a large unsold housing inventory.

Data from the Ministry of Finance show that in 2015 nationwide revenue from land sales declined by 21.6 percent year-on-year to 3.36 trillion yuan ($518.48 billion).

"Land-sale revenue can only continue to go down in the future, especially in regions where housing oversupply is more serious," Gao said.

"To improve local economic health, governments have to shift their dependence on other industries and services."

In regions dependent more on mining and heavy industries, such as the northeastern provinces, "land-sale finance" is fast declining - for example, by 25.7 percent in Dalian and 22.8 in Shenyang, the two largest cities in Liaoning province.

An official from the Liaoning provincial development and reform commission said that for northeastern provinces, economic transition is by no means easy.

In contrast, cities such as Shenzhen, in Guangdong province, have less difficulty in earning sustainable tax revenue thanks to their larger diversity of industries and stronger innovative power.

Xu Shuang, CEO of Shenzhen-based Acumen Robot Intelligence, said the city has for many years provided financial support and a good environment for startups and not many cities in China can offer the same level of benefits to entrepreneurs.

Shenzhen's success is hard to copy, Gao said. But governments of other cities should respond more actively to the central government's favorable policies by creating new growth industries.

The central government is also mulling imposing property tax, Gao said. If it is made into a law, it will allow local governments to have a recurrent source of revenue, instead of one-time income from land sales.