Local governments in China are still building highways, bridges and railways, as seen in this photo taken in Jiangxi province on September 6, 2024.
Photo | Future Publishing | Getty Images
BEIJING — China’s persistent consumption slump is deeply linked to the country’s sluggish real estate market, local government finances and debt.
Most of China’s household wealth flowed into real estate over the past two decades before Beijing began cracking down in 2020 on developers’ heavy reliance on debt.
Now, values of those properties are falling and developers are buying less land, which analysts at S&P Global Ratings say is sharply reducing revenues for local governments, especially at the district and county level.
It is predicted that it will take three to five years from June this year for local finances to return to a healthy state.
But “a delayed earnings recovery could prolong the ramp-up debt stabilization efforts,” Wenying Huang, director at S&P Global Ratings, said in a statement to CNBC on Friday.
“Macroeconomic headwinds continue to hamper China’s local governments’ revenue generation capacity, especially in terms of taxes and land sales,” she said.
Huang previously told CNBC that declining revenue from land sales has strained local governments’ finances for at least two or three years, and that tax and fee cuts since 2018 have led to an average 10% drop in operating revenue across the country.
This year, local governments have been struggling to restore revenues, already struggling businesses have little incentive to hire or raise wages and consumers are growing increasingly anxious about their future incomes.
Recapture of tax revenue
As authorities scrutinize records for potential corporate and government missteps, dozens of Chinese companies said in stock exchange filings this year that they had been notified by local authorities that they owed back taxes related to operations dating back to 1994.
The claims range from 10 million yuan to 500 million yuan ($1.41 million to $70.49 million) and cover unpaid consumption taxes, undeclared exports, late fees and other charges.
In the relatively wealthy eastern province of Zhejiang, Ningbo Bohui Chemical Technology said local tax authorities in March ordered it to refund 300 million yuan ($42.3 million) in revised consumption taxes as a result of the “reclassification” of aromatic derivatives extraction equipment it produced after July 2023.
S&P’s Huang forecasts that Jiangsu, Shandong, Shanghai Municipality and Zhejiang — China’s top provinces in terms of tax and non-tax revenue generation — will see non-tax revenue growth exceed 15% year-on-year in the first half of 2024. “This reflects governments’ efforts to diversify revenue sources, especially as other major sources face increasing challenges,” he said.
The developments caused an uproar online and further eroded already fragile business confidence.Since June 2023, the CKGSB Business Conditions Index, a monthly survey of Chinese companies, has been hovering around the 50 level, indicating contraction or expansion.The index fell to 48.6 in August.
Retail sales have only recovered slightly from their lowest levels since the start of the COVID-19 pandemic.
Camille Bournois, associate director at Rhodium Group, told CNBC that the push to recoup years-old taxes “shows how desperate they are to find new sources of revenue.”
China’s State Administration of Taxation acknowledged in June that some local governments had issued such notices but said it was a normal measure “in accordance with laws and regulations.”
The administration denied allegations of “nationwide, industry-wide, targeted tax investigations” and said it had no plans to “retroactively investigate” unpaid taxes, according to a Chinese-language translation by CNBC posted on the administration’s website.
“Revenue is a key issue that needs to be improved,” Laura Li, sector leader for China infrastructure at S&P Global Ratings, told CNBC earlier this year.
“A lot of government spending is so-called necessary spending, like education and civil servant salaries,” she said. “The government can’t cut it. [on it] This is different from expenditure for land development.”
Discussions on how to promote growth
The easiest way to increase income is growth, but with Chinese authorities focused on reducing debt levels, shifting policy from years of an investment-first approach to consumption-led growth will be difficult, analysts say.
“What is being overlooked is the fact that investment is contributing to weaker nominal GDP growth, forcing the corporate sector to cut wage spending and contributing to a sharp rise in debt ratios,” Morgan Stanley’s chief Asia economists Chetan Ayya and Robin Singh and their team wrote in a September report.
“The longer the shift is delayed, the stronger the calls for monetary easing will be to prevent inflation and property price expectations from getting out of control,” they said.
Economists said a similar debt reduction effort between 2012 and 2016 also dragged down growth and ultimately led to a higher debt-to-GDP ratio.
“We are seeing the same dynamics in this cycle,” they say. According to Morgan Stanley, the debt-to-GDP ratio is expected to rise by nearly 30 percentage points from 2021 onwards, reaching 310% in the second quarter of 2024 and rising further to 312% by the end of this year.
It added that third-quarter GDP is expected to grow 4.5 percent from a year earlier, “way away” from the official target of around 5 percent growth.
The “Grey Rhino” of Banks
Major policy changes are difficult, especially in China’s rigid state-led system.
Underlying the investment-driven focus is a complex web of local government-related entities that take on large amounts of debt to fund public infrastructure projects, often with limited financial returns.
Alicia Garcia Herrero, Natixis chief Asia-Pacific economist, said in a webinar last week that the sector, known as a financing vehicle for local governments, is, at least for banks, a “big grey rhino than real estate” – a metaphor for high-probability, high-impact risks that are being overlooked.
Natixis research has found that Chinese banks are more reliant on lending to local government financing vehicles than to property developers and mortgage lenders.
“No one knows if there’s an effective way to quickly resolve this issue,” S&P’s Lee said of the LGFV issue.
“What the government is trying to do is buy time to resolve the most pressing liquidity issues and maintain the overall stability of the financial system,” she said. “But at the same time, the central and local governments[s]They don’t have enough resources to solve the problem right away.”
