Comment on “Fiscal Prudence and Growth Sustainability: An Analysis of China's Public Debts”


Correspondence: Jiro Naito, Daito Bunka University, 1-9-1 Takashimadaira, Itabashi-ku, Tokyo 175-8571, Japan. Email:

Fan and Lv (2012) makes quite few important points relating to the introduction of China's total financial system, China's financial structure including central–local relations, recent fiscal policy, and sovereign risk. It is a highly accomplished paper with a great deal of statistical data, so it is very valuable and helpful to all of us. My comments focus on China's financial risk, especially at the local level.

China made a public investment of 4 trillion yuan in 2008 under the influence of the Lehman Crisis and, consequently, posted a fiscal deficit of 1 trillion yuan. However, the deficit decreased to approximately 700 billion yuan in 2010 and to 500 billion yuan in 2011. This decline is attributed to substantial increases in fiscal revenues, such as value added taxes and corporate taxes. The fiscal deficit has been maintained at a fairly low level as it represented nearly 1.7% and 1.1% of China's gross domestic product (GDP) in 2010 and 2011, respectively, and China has achieved the target of a deficit/GDP ratio of 2% or less. China's financial well-being is extremely good, and China has the ability to increase fiscal expenditure.

On the other hand, there are some concerns about the debt problems of local governments. The amount of outstanding debt of local governments at the end of 2010 was about 10.7 trillion yuan. This debt is concentrated in prefectural governments as a whole, and the proportion to total local debt is 43.5%, the highest among all local government levels. It should be noted that the amount of outstanding debt of local government investment and financing platforms has reached to nearly 5 trillion yuan, and the proportion to total local debt is about 46% in total, which is particularly high.

The local government investment and financing platforms are corporate organizations that have been established by local governments for financing, and it is said that more than 8000 platforms existed as of 2009. These platforms are closely linked to real-estate companies and development-related firms in particular. Since various investment and financing platforms have been established and increased in the short-term without any clear criteria on subsidies, they are strong contributors to the expansion of the outstanding debt of local governments. Information about the platforms is too unclear to enable outsiders to grasp their true state and to control them adequately, which is viewed as a problem. The percentage of debt balance of platforms and governmental sectors and organizations to total local debt has reached nearly 70% in total. These investment projects are mostly financed by the profits coming from land development and land sales, and some of them are completely reimbursed by subsidies from local governments.

Given that the Chinese economy has shown a deceleration from the end of 2011, and that approximately 40% of the debt balance will be due around 2012, this could possibly pose tremendous pressure on local government finances. Considering this situation, even though Fan and Lv state that the local government debt is manageable as long as it stops growing, I do not think it is easy for the local government debt to stop growing. Thus, I really want to know the ideas for how the Chinese government can manage this problem, especially when economic growth recently has been slowing (about 8% in the first quarter in 2012).

In addition, recent trends in the issues of local government bonds should be noted. The ban on issuing local government bonds was lifted in 2009, and 200 billion yuan of bonds were initially issued by the central government as a proxy for the local governments. In October 2011, China's Ministry of Finance announced that it would allow local governments in Shanghai, Guangdong, Zhejiang, and Shenzhen to issue their own local government bonds. Although the measures seemingly respect the autonomy of local governments, they have various limitations. The interest rates on the newly issued bonds of these four regions are in fact lower than the interest rate on government bonds. This has created the exceptional circumstance that the credit worthiness of local bonds exceeds that of government bonds. This might have been caused by the preferential treatment of local bond interest rates and the relatively high credit worthiness of the four economically advanced regions. In this situation, the risks of local government finance might not be reflected in the interest rates. The essential issuing system of local bonds in which the credit worthiness of local government bonds reflects the basic financial demands, and strengths of each local government should be established. At the same time, it is important to take advantage of issuing local bonds by substantially reorganizing the local government investment and by financing platforms to diminish their size and to reduce the local government's dependency on land revenue through this route. As described earlier, it is no exaggeration to say that the risks of Chinese finance are mostly related to local government finance. Therefore, as the Fan and Lv mention, the financial system, structure, and situation at the local level should be monitored carefully. Strengthening local finance by adjusting local taxes and by overhauling the role and financial resource is also a significant policy challenge.