How To Finance China’s Future Urbanization

At present, China’s urbanization rate is about 51%. If it continued to rise at this pace, the urbanization rate would be 60% in 2020. However, to make the process successful, China’s governments need to solve the financing problem for more infrastructures and larger welfare system first.

Till now, China’s local governments have gained a large amount of funds from banks. Through establishing financing platforms of local governments, they put lands or other fixed assets as mortgage for financing. As a result, there are great improvements in building infrastructures.

But shortcomings for such financing channels are obvious: the first is that all risks are concentrated in banks. Once local government’s fiscal status got worse, it will cause serious financial risks; the second is lack of transparency. Because the financing platforms appear in various ways, it’s hard to carry out statistics for detailed data; the third is local governments’ over reliance on land sales to repay borrowing.  Once China’s land market in the future couldn’t maintain the upward momentum, it would heavily hit the solvency of local governments.

Despite its shortcomings, the risk of a government debt crisis is not imminent. Then, over-investment caused by financing platforms of local governments is often seen in practice, and it greatly reduced the efficiency of urbanization. Why the local governments tend to over-invest? First, investments may create GDP, at the same time; many kinds of infrastructures seem to be beneficial for local residents, which create a win-win situation between governments and local people. Second, we can’t ignore the moral hazard. For local officials, they can enjoy achievements led by infrastructure building while the related costs are passed down the successor.

However, the current urbanization financing ways need to be changed. Then what ways are more reliable? Viewing from international experience, municipal bond is a good choice. The Report on Monetary Policy of the Fourth Quarter of 2012 issued by the Central Bank points out that a stable positive correlation exists between urbanization and municipal bonds in all countries – no matter in federal systems or centralisms, the municipal bond supported by tax revenue is the most efficient tool for promoting urbanization.

Does it mean that the municipal bonds issued in China may also lead to the same effect? Of course, compared with financing platforms, it is a good choice. But the problem is that the reasons for municipal bonds militating in foreign countries are because the debts for municipal facilities financing in these countries need to get the permission of local citizens, and these debts are hard constraints for local residents. In many countries, there are even risks of bankruptcy for local governments. It is just because of these hard constraints, there are efficiencies for municipal debts. But in China, these conditions have not yet been provided with. If municipal debts are introduced at this moment, I’m afraid the same process will lead to different results.

But not being qualified at present cannot be the reason for refusing the introduction of municipal bonds. On the contrary, we may wholly take urbanization financing as the reason to reform the current central and local fiscal relationships, including the budget system, and this is the mostly needed basis for maintaining the healthy development for China’s economy.

Originally published on Caijing Magazine | 2013-3-10