Local Governments’ Activities Key To Chinese Growth: Goldman Sachs

As local governments’ activities are facing multiple headwinds in China, Chinese growth hinges on the will and means of local governments, notes Goldman Sachs.

Andrew Tilton and team at Goldman Sachs in their May 18, 2015 research report titled: “Chinese growth hinges on the will and means of local governments” note that local governments (LGs) have aggressively lowered their growth targets in recent years.

Local governments’ key role in Chinese growth

According to the Goldman Sachs analysts, LGs constitute a large share of the Chinese economy. Apart from current spending, LGs are also responsible for massive infrastructure investment in local regions. Moreover, LGs’ expenditure was funded not only by on-budget fiscal revenue, but also through off-budget land sales and borrowing. Tilton and team points out that in 2009, when there was a policy push in infrastructure investment to buffer the growth shock from the global financial crisis, the true/augmented fiscal deficit was about 14% of GDP:

Chinese Growth True fiscal deficits

To highlight the key role played by the LGs, the analysts point out that local government outlays totaled about 27% of GDP.

However, the Goldman Sachs analysts point out that local government activities have to grapple with multiple headwinds. For instance, local government debt reform that started in late 2014 restricted LG’s financing channels. They note the state council issued a policy guideline in October last year to restrict LGFVs from new borrowing.

Chinese Growth Declining LGFV borrowing

Weak land sales restricted LG finances

Tilton et al. highlight that the correction in property markets has been weighing on land sales revenue, which has been a major source of local government off-budget income. The analysts anticipate land sales revenue would likely to decline sharply this year. Moreover, assuming that land transactions stabilize from now onwards, they anticipate full-year 2015 land sales revenue to drop by around 40% from last year:

Chinese Growth Declining land sales revenue

Touching upon the persistent anticorruption campaign complicating incentives further, the analysts highlight that local officials now feel less keen to spend public money so as to reduce the risks that they may become involved in corruption probes. As set forth in the following graph, since the new administration came to power, there have been a large number of senior government officials investigated on corruption charges:

Chinese Growth Persistent anticorruption campaign

However, the Goldman Sachs analysts point out that not all provinces have been equally hit by the anticorruption drive. In the following exhibit, the darker the color, the harder the province was hit by the anticorruption campaign:

Local Governments' Activities Key To Chinese Growth: Goldman Sachs

The following graph reveals that those regions that were hit more by anticorruption measures tended to display a bigger slowdown in fiscal spending:

Chinese Growth Sharp decline in fiscal spending

Policy measures that can support LG finances

The analysts argue that financing could potentially become a tighter constraint on Chinese growth, as local governments could struggle to come up with adequate funding to undertake large amount of infra FAI:

Chinese Growth Infrastructure FAI

However, they also believe policy measures to ease LG financing constraints are likely. Some of the policy measures could include: enhanced PPP, leeway for LGFV borrowing, SOE privatization and possible support from policy banks as well as indirectly from PBOC.