[The Viewpoint of Dongki Kim] The Ticking Time Bomb of the Chinese Economy: Local Financing Platforms

Rapid Growth Driven by Local Urbanization
Local Financing Platform Debt Soars to 66 Trillion Yuan in 2023
Total Debt Approaching Combined Central and Local Government Levels
Key Factor Behind Moody's Negative Outlook on Chinese Sovereign Bonds
Unresolved Debt Crisis Could Lead China into Prolonged Recession Like Japan

Dongki Kim, author of The Power of Geopolitics and The Power of the Dollar, and attorney

In December last year, the credit rating agency Moody's downgraded the credit outlook for Chinese government bonds from stable to negative. One of the reasons cited was the severe debt problem of local financing platforms (地方融資平台), organizations under local governments.

In 1994, tax reforms adjusted the tax revenues between the central and local governments in China, significantly increasing the central government's share of tax revenue. Additionally, local governments were restricted from borrowing and providing debt guarantees. Struggling with insufficient funds, local governments established local financing platforms under their jurisdiction to finance infrastructure construction and related funding. The first was established in 1998. Currently, about 12,000 various local financing platforms are active.

Since revenues from real estate-related sources such as land use rights transfer fees belong to local governments, they developed a strong desire for land development. Local financing platforms, having acquired land use rights from local governments, borrow from banks using these rights as collateral, then prepare the land and sell the usage rights to developers. The sale of land use rights by local governments surged from the early 2000s. From this point, numerous development companies emerged, and China's urbanization rapidly progressed.

Following the 2008 financial crisis, local financing platforms grew dramatically. To avoid an economic downturn, the Chinese government decided on an investment of 4 trillion yuan and entrusted its execution to local governments. Local governments raised funds through local financing platforms, and the central government tacitly approved this. Banks and investors perceived the debts of local financing platforms as implicitly guaranteed by local governments and actively provided funds. Thus, the debts of local financing platforms were called hidden debts of local governments, and their scale expanded rapidly. It is estimated that about one-third of new bank loans in 2009 went to local financing platforms. These platforms expanded like an octopus with multiple subsidiaries, engaging in businesses unrelated to infrastructure.

The Chinese government monitored the debt issues of local financing platforms and imposed restrictions in 2014. In response, local financing platforms issued corporate bonds and raised funds through financial methods other than loans. In 2018, bonds issued by local financing platforms accounted for about one-third of all corporate bonds. These bonds were mainly purchased by individuals and companies as investment products, trust products, public and private funds, and insurance companies. As a result, the risks of local financing platforms spread throughout the entire financial system.

The situation changed drastically in 2020. The COVID-19 pandemic worsened the economy and strained local finances. Moreover, the Chinese government tightened real estate financing regulations, severely impacting the entire real estate sector. Revenues from land use rights transfers and tax income for local governments also decreased. Consequently, local governments resorted to raising funds through local financing platforms, increasing their debt further.

According to the International Monetary Fund (IMF), in 2023, the debt of local financing platforms reached 66 trillion yuan, approaching the combined total of 30 trillion yuan in central government debt and 40 trillion yuan in local government debt. It is estimated to continue increasing, reaching 102 trillion yuan by 2027.

The Chinese government is also taking steps to address this issue. It officially recognizes the debts of local financing platforms as local government debts, refinancing them by issuing local government bonds, and the central government supports local governments by issuing national bonds or arranging debt restructuring with banks, including loan maturity extensions. However, fundamentally, these are temporary measures unless the structural shortage of local government resources is resolved.

Local financing platforms have been a key tool for China's development over the past 20 years but have now become a significant burden. Failure to resolve this issue could lead China down the path of Japan, falling into a prolonged recession. This has become an important variable for China's future.

Kim Dong-gi, author of 'The Power of Geopolitics' and 'The Power of the Dollar,' and attorney