Local governments in China are confronting major debt issues as the economy deteriorates. Although the Chinese government does not use the term “bankruptcy,” several cities are, in fact, insolvent.

The Chinese government calls it “fiscal reorganization” instead.

The Oxford Journals, in collaboration with JSTOR, have released a report on China’s finances. In the report, the team mentioned the term “fiscal reorganization” in appendix 766.

The Oxford report mentioned a vast increase in challenges when balancing income and expenditure due to the inefficacy of the system. Therefore, financial reform is a necessity.

China’s first proposed fiscal reorganization under the “Local Government Debt Risk Emergency Response Plan” in 2016. The fiscal organization must be initiated when the government’s expenditures exceed 10% of its funds.

Most local governments in China are struggling to make ends meet, and many cities are almost certainly on the verge of bankruptcy.

According to Sina, balancing revenue and expenses challenges remained even when the government took measures and maintained “zero growth” during the fiscal restructuring period.

The case of Bengbu city in Anhui is also worth noticing.
On January 17, 2022, the municipal website indicated a GDP growth rate of 0% in 2021.

Unsustainable industrial transformation and upgrading and the epidemical affected the city’s growth rate of major economic indicators.

According to the Secretary of Anhui, this is the bottom rate.

According to the report previously published on the official website of the Bengbu Municipal Government, the regional GDP target is 8.5% for 2021. However, the city achieved 0% for the whole year.

According to the unified accounting results of the regional GDP, the city’s GDP in 2021 was about 199 billion yuan (30 billion dollars), a year-on-year decrease of 2.1% at comparable prices.

On December 28, 2021, Caixin published a report called “Hegang Heilongjiang Province Announces Financial Restructuring insufficient financial strength to pay principal and interest on maturing government debt.”

As a result of this news, Hegang became the first city to declare bankruptcy publicly.

Hegang’s general public budget revenue in 2020 was 2.3 billion yuan (347 million dollars), down 7.8% from the previous year. However, the expenditure was 13.7 billion yuan (nearly 2 billion dollars).

It can be seen that Hegang’s expenditure is about six times greater than its revenue.

The government debt ratio to revenue is known as the fiscal debt ratio.

According to international standards, the risk warning line for a local government fiscal debt ratio is 80 to 120. But, according to the “Citi Debt Ratio Ranking List” released on October 5 last year, 85 Chinese cities hadd debt ratios greater than 100% in 2020.

In addition, 75 cities have debt ratios that have more than doubled since 2019.
Among them is Guiyang, a city in Southwest China, with a local government debt ratio of 929%, roughly 10 times the risk alert line. The debt ratios of front-tier cities reached 200%, while the top 10 cities in 2020 all exceeded 500%.This ranking shows that most local governments in China cannot make ends meet, and their debt ratios far exceed the warning line of 85. It’s rare for outsiders to understand how serious these Chinese cities’ economic woes are until it’s impossible to hide.

In a study conducted by Oxford Saïd, economic researchers called into doubt two major assumptions concerning Chinese infrastructure projects. The first was whether infrastructure investment added value to the economy. The second point to consider was whether China had a distinct advantage in terms of infrastructural development. They claimed that both were fallacies. Dr. Alexander Budzier, one of the researchers, said that in many projects they had studied, the users simply had not shown up. “The cars don’t show up on the roads and bridges, and the riders don’t turn up on the trains. That means the schemes don’t generate the revenue they need to pay back their loans,” they said.

Why have the local governments’ debts grown so big?

‘Unproductive investments’ that lead to poor income

China has spent over $116.8 billion on railway projects in 2019. In the same year, the Beijing-Shanghai High-Speed Railway Co., Ltd revealed China National Railway Corporation’s report on the revenue for the first time from eighteen railway bureaus. Twelve encountered economic losses and were expected to continue to lose money in the future. Moreover, according to a World Bank research released last year, only five of the 15 fastest 350 km/h lines could cover their operational and capital expenditures. At the same time, six were unable to pay their loan interests. The situation was even worse for the 250 km/h lines, which accounted for the majority of high-speed traffic: only five of the 16 lines could cover operating and maintenance costs, and none had enough profit to pay back interest, let alone their debt principal.

In the study, professor Atif Ansar, an expert in China’s infrastructure development spending, stated that less than a third of China’s 65 highway and railway projects that he appraised were “genuinely economically productive.”

Apart from those national-scaled infrastructure projects that are financially unprofitable, scattered all over China’s mainland are public projects that could be considered a waste of money.

A high school located in Zhen’an county, Shanxi province, drew public attention due to its over-engineered design. The criticism was so bad that they had to partially remove some of its noneducational facilities in 2020. $100 million was the amount of money invested in the school—which was considered overbearing for a county that just got out of the national poverty list in May 2019. The school consists of two dozen buildings, a koi fish pond, a pavilion, and a rock garden. Its students complained about the over-priced meals and the inconvenience of traveling, as many lived far away. Teaching staff complained that the school squandered money on facilities instead of improving the quality of the education.

Economists from China’s primary economic regulatory agency, the National Development and Reform Commission (NDRC), found significant waste and inefficiency in China’s fixed-asset investments. China’s financial losses in infrastructure projects have amounted to over a third of the country’s $28.2 trillion debt. There’s no doubt that capital misallocation has grown into a serious problem, too large to ignore for the Chinese local authorities. But there is one more problem that is worth taking into consideration. How can local authorities keep on raising funds for investment? Furthermore, they are even backed by CCP policies. There might be three reasonable explanations behind this borrowing—investing loop.

Chinese economic growth model based entirely on GDP quota

The CCP uses the GDP index to determine the country’s annual growth target. Economists have agreed that the GDP was “never about the performance of the system itself,” especially in the case of China. In China, even nonprofitable investments are counted in the GDP statistic. The growth objective for a specific period is set well in advance. To meet it, numerous organizations, including local authorities, participate in the necessary activities, frequently financed by debt.

Matthew C. Klein and Michael Pettis explained in their book “Trade Wars Are Class Wars: How Rising Inequality Distorts the Global Economy and Threatens International Peace” that: “The easiest way for officials to hit their targets is, therefore, to tell the state-run banks to lend to favored companies to invest in as much infrastructure, manufacturing, and real estate as necessary. Whether the investments are worthwhile is irrelevant. All that matters is that quantity of spending generates enough reported GDP to meet the central government’s objectives.”

Chinese officials recklessly pave their way to meet the local GDP growth quotas

Sixth-tone, a Chinese language media outlet, stated that “One major motivator is the fierce competition between localities that characterizes the past 40 years of Chinese economic growth. In China’s development model, local authorities are primarily responsible for promoting local economic development, and local officials have strong incentives to boost growth. The more revenue in the local treasury, the higher the chances of promotion, and the more the rent-seeking opportunities.”

Once Beijing lays out its quotas, the local authorities are expected to generate a certain amount of investing activities and borrow as much as they can. For so long, the officials’ performances have been evaluated completely based on their ability to create regions’ economic development, which leads to reckless borrowing. Too often, the capital is used to fund unproductive projects.

Such unhealthy practice has led to two significant consequences. First, to achieve the target, local officials not only invest in nonprofitable projects but also pour money into projects that have no practical value or so-called “vanity projects.” Second, since infrastructure projects often take time to generate revenue, local authorities still have to take on more debt to secure the yearly growth quota and, more importantly, to pay for the upcoming loan interests. In other words, they try to replace old debts with new ones. So how exactly did they spend the capital that comes from the hard-earn money of the Chinese?

The Chinese officials tend to waste capital on projects whose primary goal is to break a Guinness World Record. A 22-minute-long video titled “How Dushan burnt 40 billion” described the reckless “investing” of the county’s officials on vanity projects, circulated on Chinese social media around July 2020. Standing out was a now-abandoned wooden building that was 329 feet high. Officials poured $28,6 million into the project and expected it to score three Guinness World Records. Instead, the building was left unfinished, and Dushan fell into the $5.7 billion debt crisis, while its total local income in 2018 was only over $156 million.

Local authorities also know how to cook their books. To meet the GDP targets, they simply fabricate the economic data. Xi Jinping’s anti-corruption probe has found countless cases of financial data fraud across the country from 2017 to 2021. Liaoning, a province in the northeastern rust belt, became the first to admit to falsifying economic data in January 2017.

On the one hand, they would meet the quotas, and the better the figures, the more promising the officials’ political career path. On the other hand, the local government could even secure more loans from state banks with the artificial credit portfolio. Since a bad portfolio would mean more collateral assets would be required, making it harder for the local authority to get approved for a loan.

CCP’s economic growth model and cadre management:

An invitation to corruption “Behind almost every debt-ridden region is an ambitious “big boss,” or “yi ba shou”, looking to build a reputation for themselves,” “at the end of every trail of unfinished vanity projects is a corrupt leader.” Fang Mingyue, associate professor of economics and management at China Agricultural University

The statement revealed that one of the reasons for the corruption that spread like cancer in China was the CCP’s decentralized cadre management system.
The CCP made a decentralized reform called “managing one level down” in 1984, which gave local governors the absolute power in making decisions. Scholars of The Australian National University Børge Bakken and Jasmine Wang gave a clear statement about this reform, “under the reformed cadre management system, the central leadership managed provincial cadres only. Provincial officials took over the appointment and management of prefecture-level cadres, who in turn were set to manage and appoint county-level cadres who could then manage township officials. These reforms significantly empowered the lower levels of the administration, and the local Party chiefs—the “number ones” (yi ba shou), thereby creating a Party aristocracy with nearly unbridled power with total discretion and no accountability.”

Infrastructure investment has become a hotbed for corruption. “Officials in the provincial transportation office, high and low, racked their brains for ways to get their claws into expressway projects,” read a CCP’s report in 2014. Corruption appears in every aspect of China in various forms.

Taking bribery by approving construction contracts: Chen Miangxian, a Hunan transportation official, collected $4.4 million in kickbacks in just two years for diverting contracts on eight expressway projects to appreciative companies in 2016. Believing bridges and expressways would bring prosperity to Hunan, Chan and other authorities quadrupled the province’s expressways from 872 miles in 2005 to 3,778 miles by the end of 2016. Not long after, Chen was charged with corruption. “Connections became a magic drug for scoring engineering contracts,” he said. Over 27 Hunan transportation officials have been deposed as a result of anti-corruption investigations from 2010 to 2016.

China’s signature “tofu dregs” projects directly result from local authorities’ replacing standard-quality building materials with bad ones. For example, during the construction of the Taixing Railway in Shaanxi Province, yellow mud appeared on the construction site after a light drizzle. According to a construction contractor in Shanxi province, China Railway 12 Administration’s project manager Li Yousheng requested the workers to use loess soil to backfill the culverts. Unfortunately, the unstable loess soil was dug up directly from the road, which cost zero, while the qualified materials required dozens of yuan per ton.
The appealing incentives from large contracts and numerous opportunities for cost inflation and scrimping on quality supplies have made the infrastructure section attractive to rent-seekers.

There might be someone thinking. Corruption is nothing new as it might appear in every nation, every institution. Governors are making efforts to tackle corruption, so why make China’s case such a big deal? Here is the reason why. Corruption elsewhere in the world is not at all the same as that of China. Under the ruling of the totalitarian regime, officials and businessmen collude with each other to “get rich together.” Minxin Pei, a Chinese-American political scientist and expert on governance in China, called such a relationship as the “Outsider-Insider Collusion.”
The downfall of the CCP’s former Minister of Railway Liu Zhijun in 2013 revealed the dark picture of China’s corruption reality. It was one of the most scandalous corruption cases of the railway department at the time. During his eight years in office, more than 4350 miles of high-speed railway was built, which cost a whopping $470 billion of investment. But, more importantly, his business tie with Ding Shumiao was disclosed.

Ding Shumiao, a Shanxi businesswoman, assisted 23 companies in obtaining 57 railway construction contracts worth a total of $29.16 billion, CCP’s mouthpiece Global Times reported. Ding also received over $470 million in kickbacks, and Liu received $7.7 million for his part. In addition, Ding was accused of offering “sexual favors to Liu by arranging an unspecified number of women for him.” As a result, the railway tycoon Ding Shumiao was sentenced to 20 years in prison and $400 million in fines.

Such corruption practice has become a phenomenon in China. For example, 54% of the 12,759 bribery cases prosecuted in China between 2014 and 2017 related to construction projects. According to a study, “Big Data of 12,759 Judicial Documents Reveal: Over Half of the Briberies Involves. Construction Projects” in 2017. Minxin Pei called it “Crony Capitalism,” describing an economic system in which capitalists profit from politicians’ rents.

Since the market reforms changed in the early 1990s, there has been an unspoken agreement between the tyrannical party and the elites: the party made room for the elites to earn money, and the elites would not betray the party. As a result, the rise of China for the past two decades has been aligned with serious corruption. Thanks to the GDP-driven economic growth model, it is not hard to tell that the CCP’s authorities and capitalists’ fortunes were made entirely on taxpayers’ hard-earn money.

At the same time, to the party itself, the looking-impressive GDP index secures the legitimacy of the dictatorial regime. The debt-investment cycle is likely to continue until the growth incentives are exhausted, and without doubt, the ongoing corruption will erode China’s economic growth potential.

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