China’s Hidden Debt Dilemma Explained in Full


China has recently seen the acceleration of trials for the unified supervision and regulation of local government debt, in a bid to completely remove the accumulated volumes of hidden debt that could pose a systemic risk to the financial system.

The Chinese central government signalled greater efforts to deal with the problem of local government debt at the 20th National Congress of the Communist Party of China (CPC) held in October last year.

Finance minister Liu Kun (刘昆) highlighted the critical importance of preventing and resolving government debt risks in his article “Strengthening the Modern Budget System” (健全现代预算制度), that was published as part of the “Report on the 20th National Congress of the Communist Party of China” (党的二十大报告辅本).

“The government should maintain strict supervision, firmly restrain the increase of hidden debts, properly resolve existing debts, and gradually achieve unified regulation of local government debt in accordance with unified rules.”

As of the end of 2022, the official balance of local government debt was 35 trillion yuan, encompassing statutory debt and special bonds.

State-owned media reports that the market remains highly concerned about the “hidden debt” (隐性债务) of local government, which refers to debts incurred by local governments in breach of regulations. Estimates vary greatly as to the size of local government hidden debt.

Lou Jiwei (楼继伟), China’s former Minister of Finance, recently wrote that analysts estimats the size of local government hidden debt to be between 30 trillion yuan to 50 trillion yuan, based on the total amount of interest-bearing debt issued by municipal investment companies that make use of bond financing.

As of the end of 2022, the interest-bearing debt balance of municipal investment companies that have publicly issued bonds stood at 53 trillion yuan. This estimate method has its flaws, however, as debts that support public projects but rely on project revenue for repayment are not categorised as local government debt.

The birth of hidden debt in China

The Chinese Politburo first mentioned the concept of “hidden debt” in July 2017, distinguishing it from “statutory debt” (法定债务) and marking a breaching from the prior convention of dividing local government debt into government debt (政府债务) and contingent liabilities (或有债务).

“Hidden debt” refers to debts that are incurred beyond local government debt quotas, involving direct or guaranteed repayment from fiscal funds or the provision of guarantees that were in breach of regulations. In essence, the term encompasses almost all non-standard borrowing conduct on the part of China’s local governments.

The Politburo’s highlighting of hidden debt arrived as part of efforts to step up the regulation of local government debt levels, due to mounting concerns over their rapid increase in the wake of the 2008 Global Financial Crisis, particularly as mediated by local financing platforms (地方融资平台).

Local financing platforms first emerged in the more affluent cities of eastern China, as innovative financing tools to support the development of local transportation, infrastructure and utilities. In order to deal with impacts of the GFC, however, local government financing platforms became convenient financing tools for the Chinese government to implement stimulus measures.

This led to a rapid expansion in the scope of borrowing, while illicit guarantees provided by local governments led to the further exacerbation of debt risk.

China cracks down on local government debt in 2017

Beijing kicked off a protracted campaign to control the hidden debt of local governments in 2017, with the launch of a slew of measures to clarify and resolve related issues.

In July 2017, the National Financial Work Conference (全国金融工作会议) declared that “local party committees and governments at all levels should strictly control the increase of local government debt, implement lifelong accountability, and investigate responsibility.”

In the same month, the Politburo said it was necessary to “actively and prudently resolve the accumulated risks of local government debt, effectively regulate local government borrowing and financing, and resolutely curb the increase of hidden debt.”

2018 saw the release of key regulatory directives for curbing local government debt, including the “Opinions of the Central Committee of the Communist Party of China and the State Council on Preventing and Resolving the Risks of Local Government Hidden Debt” (中共中央国务院关于防范化解地方政府隐性债务风险的意见) and the “Accountability Measures for Local Government Hidden Debt” (地方政府隐性债务问责办法).

The implementation of China’s new budget law in 2015 also helped to improve the system for local debt management. According to the provisions of the Budget Law, local government debt in China must be included in budgetary management as well as be made subject to quota management.

The new law mandated the establishment of a cross-departmental big data monitoring platform, and the transformation of the Ministry of Finance’s (MOF) special commissioner offices into various local regulatory bureaus responsible for the monitoring of local government debt levels.

In 2018 MOF led the completion of the “Investigation and Statistical survey of Local Hidden Debt” (地方隐性债务的清查统计). The initiative required that all local governments report their debt status, asset status, medium and long-term government expenditures, and 5-10 year debt conversion plans for individual government departments, institutions, social organizations and state-owned enterprises to the local comprehensive debt monitoring platforms established by MOF.

Since 2018, there have been no national debt surveys or new nationwide directives on borrowing in breach of regulations by local governments. China has instead adopted measures to target specific sectors or regions in order to curb growth in hidden debt.

In December 2022, Liu Kun announced that these measures had helped to keep the statutory debt-to-GDP ratio at less than 50% while local hidden debt had fallen by more than one-third.

Concerns over hidden debt lead to push for unified regulation

Despite the progress made since 2017, concerns over growth in the hidden debts of local governments in China still persist.

The Chinese government’s accountability reports continue to highlight increases in hidden debt in various parts of the country, with key issues including the illicit issuance of letters of guarantee, promises to use government funds for the repayment of platform debts, the misappropriation of platform funds for other purposes, the use of illiquid public assets as collateral for loans, and the partial conversion of institutions such as schools and hospitals into vehicles for financing purposes.

These concerns have led to a push for what MOF refers to as “the unified supervision and regulation of local government debt on the basis of unified rules. “This will encompass measures including:

  • Standardisation of the the borrowing and financing behavior of financing platforms based on multiple rounds of inspection, screening, and reporting of government debts.
  • Refining rules for asset injections, asset evaluation, asset and liability reporting, and debt risk warnings.
  • Refining rules for the borrowing and debt-raising of financing platforms.
  • The promotion of market-based risk pricing.
  • Further strengthening and refinement of accountability measures.

Bond refinancing used to resolve hidden debt

As is customary with policy implementation in China, efforts to resolve the problem of hidden debt has entailed the staging of a range of trial schemes across various parts of the country.

Starting from 2019, multiple local governments in provinces including Hunan, Guizhou, Yunnan, Liaoning, Inner Mongolia, Gansu, Sichuan, Ningxia have launched pilot schemes for the resolution of hidden debts.

A key measure of these pilot schemes is the issuance of refinancing bonds to repay outstanding hidden debt. This in essence replaces hidden debts with statutory bonds for the purposes of increasing regulatory transparency.

Observers point out that this measure also leads to unification the supervision of statutory debt and hidden debt. Each province has a certain debt quota, which provides room to local policymakers for replacing outstanding hidden debts with local government bonds.

As of the end of 2022, the local government debt ceiling was 37.65 trillion yuan, while the local government debt balance was 35.06 trillion yuan, leaving room to maneuver of around 2.59 trillion yuan. Local governments have continuously repaid their statutory debts, helping to create sufficient space to resolve hidden debts via the issuance of refinancing bonds.

in 2022, local governments around China arranged financial funds to repay a debt principal of 384.8 billion yuan. The remaining debt quota for different local governments varies greatly by region, however. Shanghai’s debt balance is 276.5 billion yuan beneath the quota, while Jiangxi has a remaining quota of 199.7 billion yuan, Jiangsu has 190 billion yuan, Xinjiang has 174.7 billion yuan, Beijing has 163.7 billion yuan, and Hebei has 141 billion yuan.

Other provinces are far closer to the ceiling for their debt quotas. Heilongjiang only has 12 billion yuan of its debt quota remaining, while Hunan has 18.7 billion yuan, and the central Chinese municipality of Chongqing 21 billion yuan.

Trial schemes accelerate

In recent years, China has stepped up the use of trial scheme to resolve the problem of local government debt levels, with some regional authorities seeking to remove hidden debts completely.

Since 2021, Guangdong, Shanghai, and Beijing have successively launched pilot schemes for eliminating hidden debts in their respective jurisdictions. Guangdong and Beijing have since announced that they achieved the goal of clearing hidden debts in 2022, providing a sound basis for initiatives in other parts of China given the economic scope and complexity of these two administrative entities.

Both Beijing and Guangdong made use of special refinancing bonds when conducting pilot schemes for the elimination of their hidden debts. From October to December 2021, Guangdong and the Guangdong-province city of Shenzhen successively issued 112.1 billion yuan of refinancing bonds to repay outstanding debts, while in December 2021, the Beijing municipal government issued 172.1 billion yuan of refinancing bonds, with all funds raised used to repay its existing debts.