Chinese local governments are still building highways, bridges and railways (pictured, in Jiangxi Province, September 6, 2024).
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BEIJING – China's ongoing slowdown in consumption can be traced to a slump in the country's real estate market, as well as strong links to local government finances and debt.
Before Beijing began cracking down on developers' heavy reliance on debt in 2020, Chinese households had invested much of their wealth in real estate over the past two decades.
Now, the values of those properties are declining and developers are reducing their land purchases. Analysts at S&P Global Ratings said this has significantly reduced local government revenue, especially at the district and county levels.
They predict that it will take three to five years for local government finances to return to health starting in June this year.
But “delays in revenue recovery could prolong efforts to stabilize debt, which continues to rise,” Wenyin Huang, director of S&P Global Ratings, said in a statement to CNBC on Friday.
“Macroeconomic headwinds continue to hamper the ability of China's local governments to generate revenue, particularly in taxes and land sales,” she said.
Huang previously told CNBC that local government fiscal accounts have been affected by declining revenue from land sales for at least two or three years, and tax cuts and fee reductions since 2018 have reduced operating income nationwide by an average of 10%.
This year, local authorities are struggling to recoup revenue, leaving already-stretched businesses with little reason to hire or increase wages and adding to consumer uncertainty about future income.
tax recovery
As officials dig deeper into the history of potential corporate and government missteps, dozens of Chinese companies disclosed in stock exchange filings this year that they had received notices from local authorities as early as 1994 demanding payment of operational-related taxes. of taxes.
They said the amounts ranged from 10 million yuan to 500 million yuan ($1.41 million to $70.49 million) and covered unpaid consumption tax, undeclared export goods, late fees and other fees.
Ningbo Bohui Chemical Technology Co., Ltd. said that even in the relatively wealthy eastern province of Zhejiang, local tax authorities ordered it to Repay the revised consumption tax of RMB 300 million (USD 42.3 million)which is the result of a “reclassification” of its aromatic hydrocarbon derivatives extraction equipment produced since July 2023.
Jiangsu, Shandong, Shanghai and Zhejiang, China's provinces with the highest tax and non-tax revenue, are expected to see annual non-tax revenue growth of more than 15% in the first half of 2024, S&P's Huang said. “This reflects the government's efforts to diversify its revenue sources, especially as its other major sources of revenue face growing challenges.”
The development caused an uproar online and damaged already fragile business confidence. From June 2023, Cheung Kong Graduate School of Business Business Condition IndexA monthly survey of Chinese companies shows the index has been hovering around 50, indicating contraction or expansion. The index fell to 48.6 in August.
Retail sales have recovered only slightly from their lowest levels since the Covid-19 pandemic.
Camille Boullenois, associate director at Rhodium Group, told CNBC that the pressure to claw back taxes from years ago “really shows how eager they are to find new sources of revenue.”
China National Taxation Bureau June It acknowledged that some local governments have issued such notices, but said it was a routine measure “in compliance with laws and regulations.”
The U.S. government has denied accusations of “nationwide, industry-wide targeted tax inspections” and said it has no plans to “retroactively investigate” unpaid taxes. That's according to Chinese text translated by CNBC on a government website.
“Revenues are the key issue that should improve,” Laura Li, sector head of S&P Global Ratings' China infrastructure team, told CNBC earlier this year.
“A lot of government spending is so-called essential spending,” such as education and civil service salaries, she said. “Unlike land development spending, they can't cut spending (on this).”
The debate over how to stimulate growth
One straightforward way to increase your income is to grow. But as the Chinese authorities Analyst reports show that despite prioritizing efforts to reduce debt levels, it will be difficult to shift policy away from years of focus on investment and toward consumption-driven growth.
“What's overlooked is the fact that investment is causing weak nominal GDP growth, forcing the corporate sector to cut wages and causing debt ratios to rise sharply,” Morgan Stanley's chief Asia economists Chetan Ahya and Robin Xing said in a note. “September report, together with the team.
“The longer the turnaround is delayed, the stronger the calls for policy easing to prevent inflation and property price expectations from spiraling out of control,” they said.
Economists point out that similar deleveraging efforts from 2012 to 2016 also weighed on economic growth, ultimately pushing up the debt-to-GDP ratio.
“In this cycle, the same dynamics are playing out,” they said. Morgan Stanley said the debt-to-GDP ratio has climbed nearly 30 percentage points since 2021, reaching 310% of GDP in the second quarter of 2024, and will climb further to 312% by the end of this year.
They added that GDP is expected to grow 4.5% annually in the third quarter, “deviating” from the official growth target of around 5%.
The “grey rhino” of banks
Major policy changes are difficult, especially under China's rigid state-led system.
Underlying the investment-led focus is a complex interconnection of local government-affiliated business entities that take on large amounts of debt to fund public infrastructure projects that often have limited financial returns.
Alicia Garcia-Herrero, chief economist for Asia Pacific at Natixis, said in a webinar last week that the sector, known as a local government financing vehicle, is “A bigger gray rhino than real estate,” at least for banks. “Gray rhinoceros” is a metaphor Target high-probability and high-impact risks that are overlooked.
Natixis research shows that China's banks are more vulnerable to loans from local government financial instruments than property developers and mortgage loans.
“No one knows whether there is an effective way to solve this problem quickly,” S&P's Lee said of the local government financing platform problem.
“What governments are trying to do is buy time to address the most pressing liquidity challenges so that they can still maintain the overall stability of the financial system,” she said. “But at the same time, central and local governments do not have enough resources to immediately solve the problem.”