China Unveils New Rules to Cope with Massive Local Governmen

—China has announced new rules on how it will deal with several trillion dollars in local government debt as part of its efforts to curb financial risks and maintain social stability as economic growth slows .

(Beijing) — China has announced new rules on how it will deal with several trillion dollars in local government debt as part of its efforts to curb financial risks and maintain social stability as economic growth slows.

The new rules classify provincial and local debt by severity, restrict further borrowing and investment in many cases, and order delinquent borrowers to sell assets, restructure fiscal spending and even lay off staff.

“Debt payment capabilities of some local governments have weakened and some areas’ debt ratios have exceeded the alarm level,” an unnamed finance ministry official said in a statement accompanying the Monday announcement.

China has relied heavily on government-backed infrastructure projects and an overheated property market to fuel growth in recent years, with local authorities embracing a borrowing binge.

However, concerns are rising about potential payment defaults on local government debt as economic growth loses momentum. Beijing has issued a series of policies to rein in reckless borrowings, including banning fundraising channels other than bond issuance.

The State Council, China’s cabinet, on Monday published contingency plans for local governments to pay their debts. The plan comes two years after it said that the central government would no longer offer bailouts when defaults occur.

The plans are a “key reserve policy to fend off fiscal and financial risks” and will play “a positive role” in regulating fundraising activities by local governments and “guiding reasonable expectations of financial institutions,” the official Xinhua news agency said.

Debt risks are classified into four levels under the rules, with scenarios such as bond payment default by provincial governments tagged the most serious kind, or “degree one”, while situations including failure by a single city or county-level government ranked the lowest.

Local authorities are ordered to, among other measures, hold off new investment plans, suspend ongoing projects, or sell government assets if they fail to make payments on the principal and interest of a bond or become unable to maintain effective operation after servicing the debt, according to the rules.

They are also asked to go through fiscal restructuring when necessary, which could include cuts on expenses such as trips, training and consultation, cancelling subsidies for government agencies and employees and outright layoffs.

Investigations will be carried out if any of the four levels of risks occurs and responsible government officials will be held accountable even if they have left their posts, the plans say.

The central government will intervene when degree one risks emerge and may lend the funds for payment, which are to be repaid by local authorities afterwards, they say.

China in March capped total outstanding debt of local governments at 17.2 trillion yuan ($2.5 trillion) for this year. Official data showed local government debt was at 16 trillion yuan at the end of 2015.

Economic growth weakened to 6.9% last year, the lowest in a quarter of a century, and has further slowed to 6.7% in the first nine months of this year.

Contact reporter Fran Wang (fangwang@caixin.com); editor Ken Howe (kennethhowe@caixin.com)