China's Debt Dilemma: The Power Moves Behind Beijing's New Strategy

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China's Debt Dilemma: The Power Moves Behind Beijing's New Strategy
China's Debt Dilemma: The Power Moves Behind Beijing's New Strategy

In a move reflecting increasing concerns about local government debt risks, China is formulating a "basket of measures" which could witness special bond issuance, debt swaps, loan rollovers, and an action that Beijing isn't typically known for: delving into the central budget.

China's Debt Conundrum: Acknowledging the Elephant in the Room

Chinese authorities made a commitment last month to alleviate these debts, indicating apprehensions about potential cascades of municipal debt defaults that could throw the financial sector off-kilter.

This gesture by the leadership is seen by economists as being markedly different from April's tone, when the Communist Party directed for "strict control" over local debts. One could deduce that Beijing has had a sobering realization: it may have to urgently inject funds to rectify the situation.

This shift in perspective could pave the way to a viable solution for China's persistent municipal debt crisis. After long insisting that local governments handle their financial woes independently, this seems like a much-needed change in strategy.

Guo Tianyong, a professor at the Central University of Finance and Economics in Beijing, remarks on this nuanced approach: "The local debt problem is complex so you cannot simply say you don’t want to take responsibility." Furthermore, the extent of this structural change and Beijing's acknowledgment of the crisis's magnitude are crucial to the success of any remedial efforts, as pointed out by Logan Wright of Rhodium Group.

A Deeper Dive into the Debt

By 2022, local government debt had ballooned to 92 trillion yuan ($12.8 trillion), which is a staggering 76% of the economic output. To put this rise into perspective, it was at 62.2% back in 2019.

A substantial portion of this debt originates from local government finance vehicles (LGFVs), tools utilized by municipalities to fund infrastructure developments. With projections by the International Monetary Fund that LGFV debt will touch $9 trillion this year, there's palpable concern in economic circles.

However, one anonymous policy adviser told Reuters, "A principle should be established: not all debt will be assumed by the central government." The adviser's cautionary tone hints at the possibility of a "moral hazard." The recommendation? A shared responsibility model where every stakeholder, including financial institutions, local governments, Beijing, and the broader society, shares a part of the debt burden.

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