China to bypass provinces with direct payments to cash-strapped local governments, but revenue problems remain

Amanda Lee

China is planning to channel much of its stimulus funding directly to cash-strapped city and county governments to help revive the economy, a move that highlights the long-standing tax and spending problems between Beijing and local governments.

Beijing will create a special central transfer mechanism to direct 2 trillion yuan (US$281.2 billion) – 1 trillion yuan from the central government budget and 1 trillion yuan in special off-budget treasury bonds – to local governments to provide them with working capital.

Central government funds are usually allocated to provincial governments, who then distribute them to local authorities in their jurisdictions.

In the past, some of the funds meant for local governments were used for provincial government projects, leaving a smaller pool for city and county level authorities.

Chinese Premier Li Keqiang introduced the special transfer payment system when he delivered the government work report at the National People’s Congress (NPC) late last month.

However, the central government has yet to reveal details of how the system will work or the criteria that will be used for distributing funding. Some local governments are concerned that they might not get enough help.

“Provincial governments operate under a more favourable fiscal framework. That will allow them to better deal with the policy direction of higher spending and lower tax revenues than cities and other municipalities,” ratings agency S&P said in a research note published last week.

“Many provinces are able to deflect the impact of countercyclical [economic policy] measures more smoothly, because they delegate most capital-intensive spending to their lower-tier governments.”

Chen Yan, mayor of Guiyang city, the capital of the landlocked and mountainous Guizhou province in southwest China, said the central government had a history of favouring poorer regions, with less support provided to cities.

“I suggest the relevant government departments fully assess different factors: population, demand for environmental protection, level of urbanisation, the cost of transport infrastructure and the demand for such projects, as well as the need for housing, and give cities more support when it comes to central payment transfers,” Chen, who is an NPC delegate, told local media.

Regional and local governments are already heavily dependent on Beijing for their regular operations.

This year, more than 40 per cent of spending by these authorities will rely on central government transfers and the proceeds of central government controlled bond issues, higher than any year in the past five, ratings agency Moody’s said in a report published last week.

China local government debt could hit record high as Beijing front-loads more bonds

This deterioration in local government finances is due in large part to lower revenues, after Beijing mandated cuts in business and personal taxes in the last two years, as well as cuts in social security contributions for small companies, to help boost growth.

In addition, local government income from land sales to developers – one their main revenue sources – fell 14.3 per cent in the first quarter from a year earlier.

S&P estimated that the combined budget deficit of regional and local government will increase this year to 25 per cent above total revenues, up from 14 per cent last year.

Even with a better funding transfer system, much of the money given to local governments could be wasted without stricter oversight, said Liu Xiaobing, the dean of the School of Public Economics and Administration at the Shanghai University of Finance and Economics.

Liu, who is also a delegate to the NPC, urged the central government to introduce legislation to better regulate the use of public funds, including central payment transfers.

“We can absorb the lessons learned for the reforming of the fiscal budget system,” Liu said in an interview last week with Guangzhou-based media Southern Metropolis Daily.

“Previously, the budget system lacked restrictions, [spending] classifications were not very clear, there were the problems of ambiguity, sudden spending, and so on, leading to the problems of low fiscal efficiency, wasted fiscal funds.”

Some responsibility for expenditure should be transferred back to the central government from provincial and local governments to improve efficiency, said Liu Shangxi, president of the Chinese Academy of Fiscal Sciences.

Provinces can’t seem to coordinate with each other, so the central government needs to step in

Liu Shangxi

“Projects like environmental protection should be handled by the central government … like water pollution, which spreads over several provinces. Provinces can’t seem to coordinate with each other, so the central government needs to step in,” Liu said in a blog post published on Weibo, China’s Twitter-like social media platform.

“It is also necessary to reduce the burdens on local governments, cutting their responsibilities in deciding what to spend. The reason for their financial hardship is that there are too many things to do and not enough money. If certain things are not done well or can’t be done properly, then they should be moved upwards. This would help to reduce the burden at lower levels.”

Under Beijing’s stimulus plan, local governments will be able to borrow an additional 1.6 trillion yuan in special purpose bonds to fund new infrastructure projects.

But analysts warned some of the projects selected by regional governments may not generate sufficient returns to pay off the borrowing, adding to China’s already large debt.

S&P estimated outstanding local and regional government debt, including off-budget borrowing, will rise to 240 per cent of consolidated revenues over the next two to three years – from 210 per cent in 2019 – driven by the new bond borrowing.

China may have few better options than directing the borrowings to local governments to keep the economy from sinking further, but it has made minimal effort to expand welfare provisions or stimulate consumption in hard hit areas, analysts said.

“Beijing has opted for a classic infrastructure-led stimulus, contradicting stated ambitions to move towards domestic demand oriented growth,” said Rory Green, China economist at London-based research firm TS Lombard.”

“I think this preference for old-style stimulus over new reform really reflects the severity of economic shock particularly for employment.

“Relying on tax cuts, higher unemployment benefits does not deliver an immediate boost to economic activity, especially as consumers are increasingly cautious with a preference to raise savings rather than spending.”

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