context: China’s fiscal federalism is a tug of war between central and local governments. Prior to tax sharing reform in 1994, the centre was concerned about its weakening influence on fiscally empowered localities. After the reform, local revenues did not match spending responsibilities, motivating an evasion of central budget controls. The hide-and-seek game will continue as long as the top-down structure persists.
While the new regulation provides legal reference for government investment behaviours, off-budget funds still constitute a great number of local government investments. If the official budget is not enlarged, regulation may not be effective in controlling illicit investment practices in localities, argue He Fan 何帆, Zhu He 朱鹤 and Su Xinyuan 苏欣园 from Entropy Capital.
According to them, government investments demonstrate the following features
- the public sector plays a larger role in credit expansion, taking up over 30 percent in additional debt in 2013-17
- local governments perform most investment projects; the existing central-local fiscal power distribution is in question
- 2017 infrastructure investment volume was C¥1.5 tn for central government and C¥15.8 tn for localities
- as local governments have more spending responsibilities than revenues, they are inclined to invest in short-term, for-profit projects which go against government investment objectives
- lack of funding within official government budget while off-budget financing is unregulated and opaque
While providing detailed rules targeting illicit investment practices, the regulation rightly precludes bad local investments in the name of macro-level adjustment. This expression was included in the 2010 draft but deleted in the final version, limiting government investment to only non-profit, public welfare areas where the market is inefficient.
However, the regulation mostly targets investment within official budget, falling short in addressing off-budget investment that is increasingly significant. Announced government debt reached C¥18.3 tn by end-2018, not including implicit debt which is conservatively estimated to be around C¥40 tn, say Entropy Capital researchers.