Financing for Urbanization
Note: This article is the phase result of the research project of “Urbanization and Debt Risks of Local Governments” set up by Shanghai Institute of Finance and Law (SIFL)
Compared with ordinary experience, there is still more than 20% space for China’s urbanization rate, and how to finance for urbanization construction is a great challenge.
Local Government Debt Burden
There is an expert who has measured and calculated according to the relationship between newly increased infrastructural construction investment and urbanization in the past: if the urbanization rate continues to maintain the annual increase of 1%, then in 2015 the urbanization rate will reach 55%, at the same time, the needed infrastructure investment would arrive to 11.2 trillion Yuan; up to 2020, the urbanization rate will reach 60%, and from 2012 to 2020, there will altogether engender the infrastructure investment demand of 27.8 trillion Yuan.
The collection of these funds mainly relies on the local governments. At present the local governments’ debt burdens are already quite high, and do they still have the ability to finance for urbanization? Compared with other countries, the Chinese local governments do bear heavier public expenditure responsibilities. However, this does not mean the absolute mismatch between local governments’ fiscal revenue and expenditure responsibilities.
Though it is true that local governments bear more expenditure responsibilities, they also dominate lots of purse strings at the same time. If we view the final fiscal expenditures, we will find that after 1994, the percentage of local governments’ part in the whole expenditure did not drop at all, and even rose slightly. Why? Because local governments can gain a large amount of fiscal transfer from central government. In 2011, more than 80% of the whole country’s fiscal expenditures were completed by local governments. From this angle, in the sense of basic public expenditure responsibilities, fiscal revenue and expenditure responsibilities of local governments are matched.
But due to China’s urbanization process, local government debts have accumulated to a great degree. At present the main financing channel of local governments is the government financing platforms. Compared with the crisis time when the amount was 10.7 trillion Yuan, now the platform loan balance has somewhat dropped, but the amount is still around 9 trillion Yuan. Besides, there are bonds that issued by the central government on behalf of local governments and the bonds that are organized and issued by pilot local governments themselves. The city investment bond is another important direct financing source, and in recent years it has expanded rather quickly.
Besides, in the intersectional finance industries, including commercial bank’s financial products and cooperation between trust companies and banks etc., there are some funds flowing into the infrastructure construction field. The debts of local governments in a large degree are carried out around urbanization. It is impossible for these fund demands to be satisfied with the fiscal revenue in budget, and they should not be satisfied with the fiscal revenue in budget either.
Ideal Financing Mode
The urbanization financing mode for mature market economies is mainly the issuance of municipal bonds, and the sources of repayment include property tax and payments from users, while the property tax acting as the main role. The property tax gradually recovers the benefits of urban construction, and local governments will participate in sharing the added value of properties, matching with the municipal bonds in cash flow. At the same time, the requirement for transparency is ensured mainly through bond market financing, and the market constraints of local financing is strengthened.
Compared with mature market economies, the above transparency and standardization degree of the above urbanization mode in China are rather low, and they are much influenced by the macro-control. Platform companies carry out various financing activities, and their relationship with local governments is not clear enough. Especially for the financing modes mainly relying on credit, the transparency and market discipline are rather low, so there exist the behaviors of repeated pledge and unqualified pledge etc. There exist big potential risks in intersectional financial products. Viewing from the source of repayment, local governments mainly rely on the land revenue and it is likely to cause the by-products of high housing prices etc.
For a long time, the expansion and shrinkage of local governments’ financing are much influenced by the macro-control, and lack institutionalization and standardization. The development of government financing platforms has clearly reflected the point. Since the local financing platforms started in the 1980s, once the economy going overheated (especially in 1994), such government financing platforms have been put in order for many times. But after the Asia financial crisis in 1997, the government financing platforms have developed in a large scale in order to motivate China’s economy out of crisis through large-scale investment of governments. In the financial crisis of 2008, the central government even let go and encourage the development of local financing platforms unprecedentedly, it finally pushed the Chinese economy to take the lead in realizing the fast recovery and ensure the expected economic growth rate.
The data indicates that up to the end of 2010, there were altogether 6,576 financing platform companies in the whole country. After this, with the economy being stabilized, these financing platforms again were cleaned up and rectified. From the view of macro-economy stability, the management and control for the financing behaviors of local governments have its necessity, at the same time, it is also indicated that there haven’t any urbanization financing modes of market economies in China.
Viewing realistically, China is far from the west ideal financing mode, and it is impossible to carry out it soon. The fiscal problem is related to the reconstruction of the relationship between the central government and local governments, and it also is related to the political governance reform. At present, the pushing forward of urbanization by local governments has its rationality, from this angle, it is impossible to completely eradicate local government debts.
The local governments have no rights to increase taxes, but they gain control of lands and other resources. If the local governments combine these resources with the loans of banks, they can improve infrastructure and urban look, invite investments and drive growth. The land values will thereby increase, the land transfer income of local governments will also increase, thus forming a circulation. In this circulation, the increase of land benefit constitutes the main benefit of local governments from urbanization.
In the process of urbanization, the pushing from local governments may be inevitable. Besides, in order to complete the huge supply of public housing construction, the central government must ease the access the financing channels to local governments.
Future Sustainable Financing Channels
In the future, a more abundant and complex local financing system may be formed.
Firstly, the current mode that platform companies, and relevant governmental departments and units’ acting as the agency for local governments to pursue loans will still continue. Some current projects will last for a long time, while some new financing demands will still rely on the current financing system, such as the construction of public housing.
Secondly, the percentage of direct financing will be higher and higher. Not only platform companies will be allowed to issue bonds, but also local governments would be allowed to issue municipal bonds, which can play the important role. And all these bonds will be rated and priced by market. For the increased debts for updating infrastructure, relevant assets will be formed and engender cash flow, enabling the operation according to market.
Lastly, the local governments should have more autonomous rights in fiscal revenues so as to gain advantages from urbanization and reduce the reliance on land selling. Through these reforms, the local government fiscal revenues will become more flexible, and it helps to build more transparent and marketized financial channels with more restraints.
If more tax levying rights are given to local governments, will the tax burden be increased for common people? In fact, with easier and more frequent population mobility during the process of urbanization, people will choose a place to live or start a business where tax bearing is lower and more transparent, and it will constitute restraints for local governments.
Finally three derived comments are put forward: the first one is that it will take time for establishing marketized financing modes such as local governments’ issuance of bonds etc. At present, there are quite big differences of local governments’ issuing bonds between four pilot regions in China and the western.
The bonds issued in these four places are originally the part that the central government issues on behalf of local governments, and the relevant limit and approval are under the control of central government. It is estimated that it’s hard to gain breakthrough in a short period. This involves the adjustment of the relationship between the central government and local governments and the change of the functions of local governments.
The second comment is that the current local government debt is not a time bomb, with the rapid development of economy, most debts will gradually be diluted, and many projects will display their rationality. But what can be certain is that the debt risks will emerge in individual places. From the year of paying debts, at the end of 2010, among the local governmental balance of indebtedness, the debts that were due in 2012 and debts that will be due from 2013 to 2015 occupy 11.37%, 9.28% and 7.48% respectively. The debts that will be due and repaid after 2016 occupy 30.21%. Under the sound monetary policy, the difficulties and costs for local government financing are all rising. For some regions and platforms, the repaying capital with interests will be a problem.
The third is that the local government debt problem is not only related to the problem of the financial stability for the Chinese economy, but also related to the reform of financial and fiscal system. Under the urbanization background, there are necessity and rationality for the financing of local governments. To be operable, any reform of these financing channels should be considered under the current fiscal and financial system.
Originally published on Caijing Magazine | 2013-3-10
