Authorities across China are shutting down local asset trading centers in an ongoing bid by the ruling Communist Party to tighten its grip on financial transactions of all kinds amid a mounting local government debt crisis in the wake of a burst property bubble.
The closure of local asset exchanges offers a glimpse into the murky world of local government revenues, which has relied on buoyant real estate prices, “donations” and “gifts” from state-owned enterprises and governments higher up the chain of command, as well as a network of personal favors and relationships among powerful local officials to stay solvent since late supreme leader Deng Xiaoping kicked off economic reforms in 1978.
Governments in Hunan and Liaoning provinces and Xian and Chongqing cities last week canceled business licenses issued to the exchanges, citing a need for financial risk management, the Securities Times online edition reported on March 26.
Under China’s current tax sharing system, local authorities get slightly more than half of the national revenue from taxes and fees but undertake around 85% of public spending on things such as social security and education, Bloomberg quoted financial experts as saying in January.
The result has been a system where local governments have been given huge latitude to raise funds wherever possible, making it hard for regulators in Beijing to have a full picture of financial risk across the whole country.
Many of the asset exchanges being targeted are state-owned, and have been used for the trading of local financial assets including private debt issued by local governments, and more shutdowns are likely on the way, the Securities Times report said.
“They’ve increasingly been found to be trading in banned financial products in recent years,” financial commentator Zheng Xuguang told Radio Free Asia in a recent interview. “The majority of their business is in breach of regulations.”
“[The authorities] see them as causing a lot of problems, including financial risk.”
‘Implicit debt risk’
The problem is that many of the exchanges are state-owned and endorsed by local governments, Zheng said.
“They’re completely revoking all of the privileges of these state-backed asset exchanges, which means that the government won’t recognize any of their derivative products,” he said.
“They’re trying to purge local financing platforms of anything that might cause financial shocks.”
The exchanges have also been used to trade in local government private debt, Reuters reported.
Financial regulators in China’s provinces of Hunan and Liaoning and cities of Xian and Chongqing said in statements posted on their websites about the shutdowns that the moves were part of a bid to “resolve financial risks.”
“The public, especially investors, are requested to pay attention to identifying and preventing relevant risks, choose legal investment channels, and resolutely resist all types of illegal financial activities,” an announcement from the Hunan Provincial Financial Administration Bureau on March 25 warned.
At the end of 2023, outstanding local government debt totaled 40.74 trillion yuan, including about 15.87 trillion yuan of general debt and 24.87 trillion yuan of special debt, state news agency Xinhua reported on March 11.
Last June, the National People’s Congress Financial and Economic Affairs Committee highlighted significant debt risks in certain cities and counties, noting the ongoing emergence of new “implicit debt.”
“The recent years have seen increased pressure on local fiscal operations due to the pandemic, real estate market adjustments, and other factors, leading to heightened debt repayment pressures in some regions and the continued importance of addressing implicit debt risks,” the agency quoted lawmaker Huang Shizhong as saying.
‘Cap in hand’
In a recent book about complex political and financial relationships at the lower levels of government, Chinese scholar Tian Xianhong argues that personal favors, political alliances and active fundraising have been a key driving force in ensuring funds keep on rolling in.
“The fact that state power isn’t subject to any kind of public supervision means that governments are highly likely to be extractive in nature,” Chongqing political commentator Zhang Qingli told RFA in a recent interview.
“Local governments have to spend on all manner of things, and have a number of political tasks they must achieve,” Zhang said, in a reference to targets set by the ruling Chinese Communist Party and the central government.
“When there’s not enough in government coffers, they turn to companies [to make up the shortfall],” he said.
Plummeting revenues have meant that local governments across China have struggled to pay state-sector employees in recent years.
Meanwhile, local authorities are growing increasingly reliant on money transferred from Beijing to pay for public services, as a drop in tax revenue and three years of zero-COVID costs pushed them further into the red last year, Bloomberg reported.
Transfer payments from the central government to local levels to pay for education, health care and other general spending are expected to hit 10 trillion yuan (U.S.$1.4 trillion) in 2024, the Ministry of Finance said in its budget report to the National People’s Congress last month.
Tian Xianhong’s book “Resilience” is based on research he carried out in a central Chinese town in May 2019, and documents local officials going “cap in hand” to higher-ranking departments, local companies and other institutions for money.
Informal fundraising of this kind, based on a network of personal, sometimes family, relationships and political patronage, is part of the essential toolkit of a local official, Tian concludes in the book.
‘Get them to pay up’
A resident of the eastern province of Jiangsu who gave only the surname Li for fear of reprisals said the scenario is a familiar one to him.
“Everyone in rural areas knows that local officials make their money from infrastructure projects,” Li said. “What’s more, when engaging in rural infrastructure projects, they like to seek out people [from the local area] who have done well for themselves and ask them for help, get them to pay up.”
Li said no local official could last long in their job without a network of connections to oil the wheels.
“With no connections and nobody higher up to help you, they can’t achieve anything,” he said.
Guo Min, a former police officer at the Zhuzhou city police department in the central province of Hunan, said even police departments have to engage in fundraising.
“Our police department had insufficient funds to investigate cases,” Guo told RFA in a recent interview.
“One way to solve the funding problem would be to go cap in hand to various enterprises in our jurisdiction, and ask for funding,” he said.
Another would be to ask for additional “fees” from companies requiring specific kinds of business licenses, while fines were also an important source of revenue, he said.
Translated by Luisetta Mudie.