Background Since 1980, two years after
China's economic reforms began in 1978, local governments shared their tax revenue with the
central government in a
Chengbao scheme. The arrangement allowed them to retain any surplus revenue after paying the central government an agreed amount, which ensured that local governments were incentivized to grow the local economy. However, local governments were still responsible for more than 70% of regular expenditure. Further restrictions were introduced in 1996, when the
People's Bank of China published its General Rules for Loans that prohibited local governments from borrowing in any form. It issued the first LGFV bond, the Pudong New Area Construction Bond, that supported the development of the
Pudong district of
Shanghai. However, it has also been said that the Shanghai LGFV did not utilize land finance unlike later LGFVs. The LGFV model that became ubiquitous across China began in the city of
Wuhu,
Anhui. In 1998, the Wuhu government established the Wuhu Construction Investment Company to borrow ¥1.08 billion from
China Development Bank (CDB) to invest in six projects related to highways, water utilities, and waste management, The loan was taken out for a basket of projects, allowing socially beneficial projects that were unlikely to turn a profit to be supported by those that were more likely to produce returns. However, the
maturity date of only a few years of such loans and slower economic growth also increased the financial pressure on local governments and their need to borrow. Limited land availability and protests by landowners whose land was
expropriated also made reliance on land finance unattractive. Loans by commercial banks to local governments rose by 70% between the end of 2008 and the end of 2009, In 2018, the central government announced that it would not bail out LGFVs that go bankrupt, in order to signal the need for caution to the financial markets. In 2019, LGFV bonds constituted 39% of total outstanding corporate bonds in China's domestic (onshore) bond market, with widely varying credit risks.
COVID-19 pandemic and property sector crisis (2020–present) During the
COVID-19 pandemic between 2019 and 2022, debt held by 15 provincial-level governments rose by at least 50%, with most of the increase attributed to debt held by LGFVs. In 2021, regulations were introduced prohibited financial institutions from providing fresh liquidity to LGFVs. Following these regulations, local governments are required to raise funds through issuing bonds, subjecting them to stronger oversight. Although no LGFV has
defaulted as of 2023, some have been making last-minute payments, which can indicate financial distress.
Property tax proposal In October 2021,
The Wall Street Journal reported that the central government was planning to implement a nationwide property tax, to tackle real estate speculation and provide local governments with more stable revenue. However, the report detailed widespread resistance within the
Chinese Communist Party, leading to various alternative proposals including state-owned housing. On 23 October, a five-year trial of the proposed tax was announced for select regions with particularly hot property markets, such as
Shenzhen,
Hangzhou and
Hainan. Although the property tax could reduce government reliance on land value through LGFVs, it has been estimated that a property tax could reduce land value by 50%, and that this risk to property owners was contributing to lower land sales. In April 2023, the government completed a unified real estate registration system, which could enable the property tax to be implemented.
Other work In July 2023, China's state-owned banks began providing loans to LGFVs with a repayment period of 25 years in an attempt to relieve some of the pressure.
Peking University's
Yang Yao attributed the problem of unsustainable local government debt to various political economy issues, including the moral hazard of local governments not bearing the risk from their borrowing, and frequent rotation of officials. To improve the situation, Yao proposed ¥4 billion of central government support, along with a variety of
debt restructuring options, such as integrating the budgets of all
state-owned enterprises with their corresponding governments. In 2023, a study by
David Daokui Li concluded that local government debt was 50% higher than previously estimated by the
IMF and World Bank. The study found that the majority of debts were for infrastructure, and the level of debt was unsustainable without central government support. By 2024, economists estimated that the indebtedness attributable to LGFVs had reached between US$7 trillion and US$11 trillion, the Wall Street Journal reported. Of that debt, US$800 billion was estimated to be at high risk of default. Many projects funded by LGFVs were found to be ill-conceived and poorly planned. The IMF estimated that LGFV debt in China will have grown by 60% in 2028 compared to 2022 levels. == Notes ==