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China’s Provinces Suffer Major Fiscal Hit From Covid Zero

·6 min read

(Bloomberg) -- China’s doubling down on its zero-tolerance stance toward Covid-19 is draining local-government coffers, posing a fresh threat to the economy and bond investors.

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Jilin province, in the northeast of the country, has warned of “increasingly outstanding conflicts” between spending and income. Finances at almost half of of its 60 county and district level governments are so tight they are exposed to “operational risks,” the provincial finance department said in its first-half budget execution report released last month.

All 31 provincial regions in China -- with the exception of Shanghai -- logged a deficit in the first seven months of the year. Authorities handed out trillions of yuan in tax breaks to support businesses amid the economic slowdown, as well as covered the cost of Covid Zero policies, such as mass-testing and restricting the movement of residents. Plunging land sales are adding to the squeeze by cutting a key funding source.

Pressure on local government finances is likely to intensify as the Communist Party steps up Covid-fighting efforts before the twice-a-decade congress. Health officials this month announced a raft of measures that will be in place until the end of October, including asking local governments to test residents regularly, regardless of infection levels. Lockdowns are happening with rising frequency, with Chengdu, the country’s sixth-largest city with 21 million people, being one of the most recent.

The result is municipal governments are seeking to cut spending where they can. Government employees in coastal regions have had their income slashed as bonuses and subsidies were scrapped, according to local media reports. Covid testing providers are finding it increasingly hard to get paid for their services, with some warning of the growing risk of bad debt.

Fragile Economy

“If fiscal income can’t rebound in the second half of the year, spending must be reduced as the budget deficit can’t be exceeded,” said Ding Shuang, chief economist for Greater China and North Asia at Standard Chartered Plc. “Slower fiscal spending than in the first half of the year would certainly be a drag on the economy.”

Constraints on provincial spending could impede stimulus efforts for an economy that’s struggling amid the Covid restrictions and property weakness. Official data Friday showed a slight improvement in the economy’s recovery, although it remains fragile and susceptible to lockdowns and turmoil in the housing market.

Goldman Sachs Group Inc. economists say a massive stimulus package after next month’s party congress is unlikely, and Beijing’s unconventional efforts to beef up incentives this year could limit the scope of future supportive policies.

“The unique pattern of fiscal policy this year has strong implications for policy making next year, and could significantly affect the funding conditions for the government and corporate sectors in 2023,” the economists including Lisheng Wang wrote in a note released Monday.

The situation at Changtai district in Zhangzhou city, Fujian province, underscores the challenges. The district spent 32 million yuan ($4.6 million) on Covid measures in the first half of 2022, 5.6 million yuan more than what was budgeted at the start of the year, according to official figures. Income from sales of land for commercial and residential development was zero in the same period. In order to cut spending in other areas, the district stopped giving some bonuses to officials, the statement said.

A yearlong slump in the property market is denting demand for real estate. Nationwide, land sale revenue plummeted 29% from a year earlier to 3.4 trillion yuan in the first eight months, according to the Ministry of Finance.

Tax revenues are also being squeezed. Provinces granted 2.2 trillion yuan in tax rebates this year through the end of August, a third more than was planned for the whole year. They were also tasked with cutting taxes by another 1 trillion yuan for the whole year.

While local authorities are able to raise funds via bond sales, they’ve used up most of this year’s quota -- which is set by the central government. Provinces have sold a total of 4.25 trillion yuan of bonds this year, or about 87% of annual amount permitted. Of that, more than 80% are so-called special bonds, which are mostly used for infrastructure spending rather than general purposes.

Central Support

To aid lower-level governments in particular, Beijing boosted payments to the authorities by 18% to 9.8 trillion yuan, but about 93% of the funds had been allocated by the end of June, the ministry has said.

Such support is being countered by the slowdown in the economy. The stop-start approach to Covid is suppressing domestic spending at the same time as external demand diminishes. The consensus in a Bloomberg survey is for the economy to expand 3.5% this year, which would be the second-weakest annual reading in more than four decades. Forecasters at Morgan Stanley and Barclays Plc are among those predicting even slower growth as risks mount into year-end.

Lower-tier areas in particular are struggling. Gushan township in Jiangyin city, Jiangsu province, had no income at all under the government-managed fund budget in the first six months of the year, according to its budget execution report for the period.

“The pressure on preventing and resolving local government debt risks has grown further,” the Gushan government said in the report. Uncertainties in achieving this year’s revenue target are increasing while tax breaks and Covid spending are pulling down income, it said.

Local authorities may turn to alternative measures to raise revenue, such as boosting fines. A vegetable vendor in Yulin, Shaanxi province, was fined 66,000 yuan for selling substandard celery worth 20 yuan, state broadcaster Central China Television reported earlier this month.

Debt Concerns

There’s also concern financial stress may impact the ability of local government financing vehicles to meet their debt obligations. LGFVs are companies that build infrastructure on behalf of such governments and their borrowing is implicitly backed by the authorities.

“LGFVs’ problems are set to worsen since their government owners won’t be able to mobilize as much resources to support the vehicles in servicing debt,” said S&P Global credit analyst Laura Li in a note dated Sept. 5.

Support from the central government means provinces won’t run out of money, but they will need to tighten their belts, said Luo Zhiheng, chief economist at Yuekai Securities Co.

“The more lower-tier the government is, the more serious the imbalance between income and spending gets,” Luo said.

(Updates with comment from economist.)

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