China has allocated a combined 10 trillion yuan ($1.39 trillion) in new fiscal funding to replace hidden local government debt, or liabilities that local governments do not officially report. This marks one of the largest moves of its kind in recent years.

The Standing Committee of the National People's Congress (NPC), China's top legislative body, approved a bill that raises the ceiling on local government debt by 6 trillion yuan ($834 billion) to address existing hidden debt, Xu Hongcai, deputy head of the NPC's Financial and Economic Affairs Committee, said at a press conference after the Standing Committee of the 14th NPC concluded its 12th session in Beijing on November 8.

Also starting this year, China plans to allocate 800 billion yuan ($111.2 billion) from new special-purpose bonds annually to local governments for five consecutive years, helping to resolve 4 trillion yuan ($556 billion) of hidden debt, Minister of Finance Lan Fo'an announced at the conference. The measures will add a total of 10 trillion yuan to China's debt relief resources, Lan told the conference.

Hidden burden

"Hidden debt" often originates from loans and bonds issued by local government financing vehicles (LGFVs), which are local financing entities created for municipal infrastructure projects. This financing structure emerged in the 1980s as a way for local governments to fund infrastructure needs despite limitations on their ability to incur debt directly.

LGFVs can secure loans from banks or raise funds on the open market by issuing bonds. These vehicles have greatly contributed to China's economic growth, supporting projects in urban infrastructure, utilities, toll roads and affordable housing. However, the high financing costs and low returns associated with LGFVs have led to the accumulation of hidden debt during China's fast development over past decades.

Lan stated during the November 8 conference that, thanks to the coordinated efforts of different regions and departments, the scale of hidden debt among local governments in China has steadily decreased. In late 2023, a process of comprehensive identification and step-by-step review revealed that the total balance of hidden debt nationwide stood at 14.3 trillion yuan ($2 trillion).

However, new challenges have emerged this year due to changes in the external environment and weakened domestic demand, impacting economic performance. Lan noted that tax revenues have fallen short of expectations, income from land transfers has considerably declined and addressing local hidden debt has become increasingly complex.

In many parts of China, revenue from land transfers—typically for industrial and property development—is an important source of government funds. While land is either state-owned or collectively owned in China, individuals may use land under these arrangements. Local governments often transfer land-use rights for development, compensating the original users as part of the process.

'Timely rain'

Lan described the 10-trillion-yuan debt relief package as "timely rain," which will greatly alleviate local governments' debt burden.

Additionally, 2 trillion yuan ($278 billion) of hidden debt related to renovation projects of urban shantytowns, due by 2029 and beyond, will be repaid according to existing contracts.

As a result, the amount of hidden debt that local governments need to address by 2028 is expected to drop from 14.3 trillion yuan to 2.3 trillion yuan ($320 billion).

This will substantially ease pressure given it will reduce the average annual debt reduction requirement from 2.86 trillion yuan ($400 billion) to 460 billion yuan ($64 billion)—less than one sixth of the original amount.

"Our analysis shows that local governments can resolve this on their own, and in some cases, with relative ease," Lan said. Also, the measures will lower local governments' interest burdens by 600 billion yuan ($83 billion) over the next five years.

"The funds for the debt 'swap' are generated through issuing local bonds and special local bonds. In other words, the funds are mobilized through our financial markets," Liu Yuanchun, President of the Shanghai University of Finance and Economics, told China Central Television in a recent interview.

"In addressing local government debt risks, we must not only manage the existing debt risks but also firmly curb any new hidden debt," Lan explained. He added that the Ministry of Finance, working with related departments, will adopt a "zero-tolerance" approach toward any newly created hidden debt.

China's Central Government still has considerable room to issue debt and increase the deficit, Lan said. The finance ministry is currently considering new fiscal policies to improve counter-cyclical adjustments. Counter-cyclical fiscal policies are designed to stabilize the economy by offsetting the effects of economic fluctuations. During periods of economic slowdown, these policies can boost demand through increased government spending or tax cuts.

More on the economy

"These measures will help local governments streamline their financial chains and boost development momentum," Lan said. Implementing the debt swap measures will free up resources originally allocated for debt repayment to propel development and improve people's livelihoods.

"As part of a financial policy package to strengthen counter-cyclical [fiscal] adjustments, the new policy will actively contribute to the healthy development of China's economy," Xi Junyang, a professor at the Shanghai University of Finance and Economics, told newspaper Global Times on November 8.

While easing the burden on local governments to mitigate hidden debt risks and lower interest expenses, the debt swap will ensure that local governments have greater fiscal resources to support investment, boost consumption and foster sci-tech innovation.

These efforts aim to stabilize economic growth and facilitate structural adjustments, according to the professor.

These fiscal policies came amid an array of broad policy initiatives announced by Chinese policymakers in late September, targeting different sectors of the economy, including foreign trade, the housing market and the stock market, to galvanize domestic economic recovery.

Major policy incentives include reductions in banks' reserve requirement ratio—which increases the amount of money a bank can lend—and mortgage rates for existing homeowners, as well as new monetary programs to stimulate the capital market.

The latest debt relief plan could help alleviate the debt burden on local governments and create the financial capacity for expansionary policies at the local level. "All of these objectives are closely tied to the daily lives of ordinary citizens," Liu stressed.

Only with adequate local government funding in place can critical public welfare projects be undertaken, Liu added. This funding also supports the effective implementation of the incremental policies deployed in late September, providing active fiscal backing for these initiatives.

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