China’s Local Governments Are at Risk of a Puerto Rico Moment

(Bloomberg Businessweek) -- For the amount of work they're expected to do, China's regional governments are simply not paid enough. As the economy slows and real estate enters a bear market, a financial collapse on the order of Puerto Rico's is a real possibility.

The central government collects more than 8 trillion yuan ($1.3 trillion) from local tax offices every year, then redistributes most of it across the country. But the share going to local governments has declined since a major tax reform in 1994. In 2020 they got 55% of the total, down from 73% in 1993, before the changes were enacted. Meanwhile, the regional governments, which are responsible for most public services—such as building roads and providing clean drinking water—have been spending more: Their share of total government spending in China rose to 86%, from 73%, over the same period.

They've got even bigger bills now. China's “Covid-zero” policy is executed locally. Mass testing, medical equipment procurements, and district lockdowns all cost a lot of money. Yangzhou, a city of 4.5 million people, carried out 17.6 million Covid-19 tests last August. That helped halt transmissions, but with each test costing 20 yuan, the Yangzhou government spent about 352 million yuan in just three weeks.

Local governments get about a third of their revenue from selling land they own to developers. (Another third comes from the central government, and the remainder from other sources, including fees.) But with China's real estate market in a deep slump and developers defaulting, local governments are having a tough time selling empty plots of land.

Tianjin, which had China's first omicron outbreak and has done mass testing on its population of 14 million, had budgeted for 74% growth in land sales in 2021. But that figure looks unrealistic in light of the slump. (Data for 2021 land sales are not yet available.)

Spotting China's potential Puerto Rico is not as simple as pointing at the most impoverished region: Tibet. It's equally possible that the country's municipal debt crisis could explode in one of the richest provinces, such as Jiangsu or Zhejiang. In these two wealthy regions, land sales can account for as much as half of government revenue, in part because their stronger economies push up land prices. And their economic strength makes it easier for them to borrow. Chinese local government financing vehicles have about 11.5 trillion yuan in bonds outstanding, 35% of which came from these two provinces, according to HSBC Holdings Plc.

A freeze in the credit market could prevent local governments from rolling over their debt—the same problem faced by real estate developers last year. Jiangsu, in particular, has debt maturing equal to 41% of its 2020 revenue. So Beijing must be vigilant. China's municipal debt crisis might spring out of nowhere, and anywhere.

Ren is a columnist for Bloomberg Opinion.

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