Chief Economist Warns Chinese Local Debt Sustainability Faces Challenges in Next 5 Years

(Digital Phablet) July 24 — The sustainability of local government debt in China is expected to face significant financing hurdles during the 15th Five-Year Plan (2026-2030), according to the chief economist at Yuekai Securities.

Debt management at the local government level is set to undergo substantial changes over the next five years. China should focus on further reducing its hidden debt growth by enhancing local governments’ financial management systems to lower liability risks and address the ongoing conflict between continued borrowing and fiscal stability, Luo Zhiheng stated.

As local government liabilities grow, the share of interest expenses relative to fiscal expenditures will continue to increase, which could strain regions with weaker fiscal fundamentals, Luo explained.

According to the latest data from the Ministry of Finance, the debt held by Chinese local governments doubled to CNY51.25 trillion (USD7.17 trillion) as of May 30, up from CNY25.7 trillion at the end of 2020.

Luo attributes the rise in local government debt during the 14th Five-Year Plan period to three main factors. The first is the adoption of a more proactive fiscal policy to support economic growth despite macroeconomic challenges such as the COVID-19 pandemic, an aging population, and a slowdown in the real estate market.

The second factor is China’s economic shift from infrastructure-led growth to technology innovation and consumption, leading to a temporary surge in investments. The third is the issuance of numerous local government bonds to replace hidden debts, thereby increasing the overall debt balance.

Hidden debts, or implicit liabilities, are obligations taken on by local governments through their investment and financing vehicles, which do not appear on official balance sheets and pose considerable financial risks. Since 2014, China has mandated that local governments fund projects through direct bond issuance to control the growth of hidden debts.

Although some hidden debt risks have been mitigated by establishing local government financing platforms during the 14th Five-Year Plan, signs of rising hidden debts still appear in certain regions, Liu noted. 

He recommended that China further strengthen the entire management process for local government financing and implement comprehensive performance evaluations for project funding cycles during the 15th Five-Year Plan to better regulate borrowing practices.

Additionally, China should encourage the transformation of state-owned investment companies, improve their governance structures by inviting social capital, and gradually phase out their roles in local government financing. The goal is to convert these entities into market-oriented investment firms that operate independently of government credit and possess their own financial autonomy, Luo added.