Bloomberg recently reported that Beijing is preparing to mobilize over 1 trillion yuan in loans from state-owned and policy banks to help local governments clear overdue payments to private enterprises. On the surface, this appears to be a bold and innovative step to alleviate local debt pressures and bolster private sector confidence. Yet behind it lies a harsher reality: China’s policymakers are still grappling with the country’s persistent local debt crisis.
China’s local debt woes are nothing new, nor are the central government’s efforts to tackle them. In recent years, the slowdown in the property market has slashed land sale revenues – a critical fiscal lifeline for local governments. Compounding this, the surge in local debt issuance during the pandemic years has pushed local finances to the brink. The risk of uncontrolled debt has grown acute, prompting Beijing to repeatedly intervene with debt restructuring initiatives. These measures aim to prevent widespread defaults that could unleash catastrophic ripple effects across the broader economy and financial system.
At the heart of this debt crisis lies “hidden debt,” a type of liability that includes corporate arrears and is largely channeled through local government financing vehicles (LGFVs). These entities, established by local officials to fund infrastructure and public projects, operate as quasi-commercial platforms to circumvent borrowing restrictions on their local government patrons. LGFVs raised funds via bank loans, bond issuance, and wealth management products to finance everything from roads and bridges to industrial parks and social housing. By design, they allow local governments to borrow indirectly, but their opaque operations have ballooned into a systemic risk.
Unlike officially sanctioned special-purpose bonds (SPBs), which are transparently recorded, much of LGFV debt exists off-balance-sheet and makes precise accounting impossible. For instance, unpaid contractor and supplier arrears are often negotiated privately and leave few public traces.
This opacity has led to strikingly divergent estimates of the scale of the problem. Earlier this year, central bank governor Pan Gongsheng pegged LGFV debt at 14.8 trillion yuan. In stark contrast, the International Monetary Fund estimates it to be over four times that figure and nearly half of China’s GDP. Chinese economist Li Daokui has suggested that unpaid contractor fees and civil servant wages alone total 10 trillion yuan.
Whether policymakers are underestimating the scale of hidden debt remains unclear. Regardless, Beijing’s actions demonstrate a clear intent to mitigate the risks. Since 2019, the central government has rolled out multiple debt swap schemes, allowing local authorities to issue new bonds to refinance hidden liabilities. In 2023, 12 heavily indebted provinces were permitted to issue 1.5 trillion yuan in bonds to shift hidden debt onto local balance sheets. Last year, Beijing authorized another 10 trillion yuan in local debt issuance – to be disbursed over five years – to address these hidden obligations.
In the short term, these measures have provided some relief. High-interest, short-term debt has been swapped for longer-term, lower-cost bonds to ease liquidity pressures for some LGFVs. However, the sheer scale of accumulated debt, coupled with declining land sale revenues and mounting public service expenditures, means these interventions merely delay the inevitable. As long as LGFVs rely on fiscal subsidies and local land sales revenue to service their debts, the risk of a renewed crisis looms large. Beijing’s efforts have bought time, but they have not eradicated the structural vulnerabilities driving debt accumulation.
To its credit, the central government recognizes that the core issues lies in reducing local governments’ dependence on LGFVs. In this year’s Government Work Report, Premier Li Qiang underscored the need to “remove government financing functions from local financing platforms and press ahead with market-oriented transformation of these platforms.” Some Chinese analysts have likened Beijing’s vision to the “Temasek-ization” of LGFVs – referring to Singapore’s state-owned investment firm, Temasek. The idea is to transform LGFVs into commercial entities that generate sufficient returns through investments rather than relying on government-backed financing.
This vision of “Temasek-ization” is alluring but overly optimistic, as it sidesteps stark differences between LGFVs and the global investment giant. While Temasek is wholly state-owned, its assets are ring-fenced from Singapore’s fiscal budget and managed with commercial discipline. It sustains itself through long-term investments in global markets, from technology firms to infrastructure, and its managers are held accountable through performance-linked incentives.
Crucially, Temasek operates under hard budget constraints: losses must be absorbed, underperforming assets can be sold, and government support does not arrive in the form of open-ended bailouts. Its exposure to international markets enforces transparency and external pricing, ensuring that investment decisions reflect market realities rather than day-to-day political imperatives.
LGFVs, by contrast, are entangled in a web of political obligations that stifle commercial viability. They are often tasked with funding low-return projects, like public parks or subsidized housing, to meet local government priorities rather than to generate profits. Their governance, despite a corporate facade, lacks market-driven discipline: managers are judged on fulfilling politicized quotas – say, completing a set number of infrastructure projects – rather than financial returns.
With implicit government backing, LGFVs borrow with ease but accumulate bad debts with no clear exit strategy, as selling off assets or declaring bankruptcy risks political fallout. To put simply, transforming these platforms into market-oriented entities is a tall order when their core purpose remains tied to government mandates rather than sustainable revenue streams.
Instead of pursuing an idealized transformation, Beijing should prioritize pragmatic steps to unwind the LGFV model. For heavily indebted platforms, this means mergers or asset sales to separate viable commercial projects – like toll roads with steady revenue – from fiscal burdens like unprofitable public works. Platforms focused on public services, such as water utilities, should be folded back into transparent budget processes that are subject to fiscal oversight.
Meanwhile, LGFVs with market potential, such as those managing commercial real estate, need clear ownership structures and performance-based governance to compete without relying on government bailouts. These steps would curb the systemic risks posed by LGFVs while laying the groundwork for a more sustainable fiscal system.
The longer-term challenge lies in rebuilding China’s fiscal system. Land sale revenues are no longer the reliable windfall for local governments that they once were. A more sensible tax-sharing framework and clearer delineation of central-local fiscal responsibilities are essential. Complementary reforms – transparent budget constraints, rigorous performance evaluations, and enforceable exit mechanisms – are equally crucial. Only when the impulse to “build projects” gives way to financial discipline will borrowing costs stabilize. And only then can the historical role of LGFVs – and the macroeconomic risks they pose – finally be laid to rest as Beijing has hoped.
China’s latest move to inject liquidity into LGFVs signals both determination and desperation. While it may stabilize private sector confidence in the short term, it is a reminder that the local debt crisis remains a formidable obstacle. Without bold, structural reforms, the specter of hidden debt will continue to haunt China’s economy for decades to come.
