Beijing Cracks Down on Local Government Finance Under Guise of Service Purchases

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China’s central government is cracking down on the illegal financing of construction projects by local governments under the guise of “service purchases,” as part of efforts to stymie systemic financial risk.

Analysts have long observed that local governments in China have been wont to use nominal procurements to provide de facto financing to infrastructure and construction projects within their own jurisdictions.

The method became especially widespread in the second half of 2015, emerging as a mainstay for local governments to invest in or finance infrastructure undertakings.

Figures released by the National Audit Office in June discovered that government service procurements had been used to provide as much as 17.565 billion yuan in financing across a total of four provinces of China.

After pursuing a concerted deleveraging campaign with the aim of reducing systemic financial risk, Beijing is now cracking down on the risk inherent in these illicit or covert forms of local government financing.

China’s Ministry of Finance recently issued Document 87 – the “Notice on Firmly Preventing Illegal and Illicit Financing by Local Governments in the Name of Service Procurements,” a directive that targets this specific form of government funding with unprecedented vigour.

The document prohibits local government from including raw materials, fuel, equipment, and commodities, as well as buildings and the construction of new buildings or the renovation, expansion or demolition of existing buildings as service procurement items.

It also strictly prohibits the construction of various forms of infrastructure including railroads, highways, airports, water and power facilities, communications facilities, as well as educational, technological and medical facilities, as government service procurement items.

In addition to excluding tangible goods and buildings from the bill of service procurement items, Document 87 also strictly forbids the inclusion of financing services provided by financial institutions as well as non-financial institutions such as financial leasing companies.

Local government is also require to more strictly comply with the “relevant requirements of budget management systems,” which means that any service procurements cannot be tacked onto budgets that have already been set for a given financial year.

The launch of the direct has already had an impact on local government construction projects in various parts of China that were financed in breach of regulations.

According to China Government Procurement Net, construction or infrastructure projects in Hebei province and Shandong province have been scrapped because of financing under the guise of service purchases.

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