In May, a deputy mayor of a midsize city in central China flew down to see me in Shenzhen, where I sit on a government advisory panel for financing small and medium-sized businesses. He wanted a favor. “Can you help arrange financing for our sports center?” he asked. It’s going to be one of the largest in central China.”
It was another tale of woe about a half-finished project in desperate need of more money. I’d heard this song before.
After Lehman Brothers fell in 2008, the Chinese government panicked and unleashed an ambitious stimulus program by expanding public works projects to build roads, railroads and municipal buildings. China avoided a recession but is now left with a lot of half-finished or barely used infrastructure. In the process, the coffers of many local governments were emptied.
The sports center is symptomatic of a nationwide problem. Partly financed by the sale of adjacent land sites, the project was dubious to begin with: It is a small city for a big sports center, and there are similar stadiums in nearby cities. After three years of delays, it had serious budget overruns and remained unfinished. In early 2012 a trust company sold debt for the center that was guaranteed by the local government’s stakes in two local power plants.
The city’s officials tried everything to get banks to chip in, to no avail, as the cash-flow projections for the facility were a stretch of the imagination. What about selling more land? That was a tough proposition, too, as the city was already saddled with too many vacancies and real estate developers were no longer eager to invest. What’s more, city officials had exceeded their land-sale quotas, which are set by Beijing to prevent too much farmland from being turned into real estate.
“We may have to do the inevitable and sell the family silver, such as controlling shares in the local bank, hotels, water utilities and industrial companies,” the deputy mayor said during his visit to my office. The good news is that Beijing generally does not stand in the way when local governments want to sell such assets.
In the past year, with a slowing Chinese economy coming under increased scrutiny, so-called local government financing vehicles — schemes like the one to finance the sports center — have become a source of concern, as banks and analysts worry about a wave of bad debts. Some estimates put local government debts at more than 12 trillion yuan ($2 trillion) as of the end of 2012. That’s equivalent to about 25 percent of China’s 2012 G.D.P. Some economists fear the day of reckoning will come in 2014, when most debts will come due. That will spark a crisis of confidence, they say, and a collapse of the economy.
I dismiss such alarmist predictions.
First, there is no such thing as local government debt. China does not have a federal system; all tiers of local government are branches of the central government. At the end of the day, the central government stands behind all levels of government. It determines the tax-revenue sharing formula with each local government, makes all political appointments, and says if a local government is allowed to sell bonds or not. In many cases, the central government even sells bonds “on behalf of local governments.” So, there will never be a Chinese equivalent of Detroit, a metropolis that goes bankrupt while the rest of the country looks on.
Second, even as the economy has been liberalized over the past 35 years, the government has substantially increased its slice of the G.D.P. pie, leading to more income and a healthier balance sheet. The ratio of total fiscal revenue to G.D.P. reached 22.6 percent in 2012 on the back of new taxes, higher tax rates and better collection methods.
While much fiscal revenue has been squandered, at least some has been reinvested each year to grow government assets. Today, the government owns controlling stakes in a huge number of banks, telecom operators, ports, roads, railroads, real estate holdings and industrial companies. Not to mention its over $3 trillion in foreign government bonds.
My friends from the central Chinese city indeed have a financial headache. But it is neither the end of the world nor even alarming: Bad debts can and will be covered by the central government.
Skeptics who look at the national economic picture, however, may find good reason to worry. But the problems on the macro level will, in fact, set in motion much-needed reforms — and the net result will be a stronger economy.
Since 1978, when the policy of liberalization began, the state sector has grown so large that it is stifling the private sector and, even more important, holding back the economy.
With ready access to subsidized bank credit, the state sector has overexpanded and worsened the problem of industrial overcapacity. It has wreaked havoc in many industries with its disregard for profitability. It consumes more than half of bank credit, forcing small and medium-sized businesses to seek high-cost finance outside the state banking system. Finally, it competes with the private sector on unfair terms, causing resentment and making corruption more endemic.
Thus, to avoid long-term stagnation, China will soon have to embark on a second wave of privatization, as the government is running out of options to fund further growth. Its fiscal deficits have risen quickly, banks are overextended and land sales have become untenable. Moreover, there are growing calls for the government to replenish the inadequate social security fund to meet the needs of an aging population.
This inevitable wave of privatization will bring with it the added benefit of unleashing a corresponding wave of restructuring in what has become a grossly inefficient and bloated economy. Luckily, the new leadership seems to recognize that this is necessary. A consensus appears emerging in the policy making circles that, as fiscal stimulus runs out of steam, structural reforms can provide huge potential for the next leg of development.
The sports center in central China should be completed, but it should be taken over by a private company. My recommendation to the deputy mayor was to auction it off, and I suspect he may soon heed my advice.
Joe Zhang is chairman of a microcredit company in Guangzhou, China, and the author of Inside China’s Shadow Banking: The Next Subprime Crisis?