Gisela Färber and Zhijie Wang, Speyer University, Germany
Sintesi
Il debito pubblico subnazionale costituisce un problema sia per la Cina che per la Germania. In entrambi i casi disequilibri nelle relazioni fiscali intergovernative, gettito da fonti proprie inadeguato o assente a livello subnazionale, informazione incompleta sul livello reale del debito pongono rischi e sfide molto seri. Misure ad hoc per mantenere l’indebitamento sotto controllo, compresi i cosiddetti “freni del debito” in Germania, o l’emissione di bond locali in Cina, difficilmente sono sufficienti e potrebbero peggiorare la situazione. Nonostante differenze nei rispettivi sistemi di governance, vi è molto da imparare dalle esperienze di uno e dell’altro.
Subnational public debt is a problem in both China and Germany—and there are lessons to be drawn from each country for the other. Total public debt amounted to 54% of GDP in China in 2012 and 74% in Germany in 2015 of which subnational governments (provinces, prefecture cities, counties, towns and villages) had a share of 53% in China and respectively 37% Länder and local governments in Germany. Subnational public debt significantly varies across the lower levels of government and among the governments at the same level. The total amount of subnational pubic debt is not very transparent: in China, it has not been counted among the official public debt data because the budget law did not permit direct borrowing until 2015, and much of the debt was due to “off budget” special vehicles and entities owned by local governments. In Germany, local governments in certain states borrowed illegally (so-called cash credits) against their current accounts over many years, or accumulated arrears.
In Germany, the liabilities of a few Länder have been examined critically. Similarly, the high level of indebtedness at the local level in China has begun to attract attention, and managing local risks is one of the main elements of the 2018-20 reform program adopted by the government after the 19th Party Congress. The Chinese National Audit Office reported that local government obligations were 17.9 trillion Yuan (2.56 billion Euro or 30.44% of GDP) by the end of June 2013, which is 1.5 times as high as the debt of the central government .
Since January 2015, China has allowed provincial governments to issue bonds directly for the first time, but the financing dilemma has not changed for the lower levels of local government. Germany in contrast has adopted the so-called debt brake in 2009 requiring balanced budgets from 2016 for the Bund (Federal Government) and from 2020 for the States. Municipalities and counties expect increased budget pressure with declines of transfer payments when the States consolidate their budgets, and also push functions down to the level that is not subject to the balanced budget rule.
Table 1. Subnational debt in China aggregated at provincial level per capita (2012)
Source NAO (2013), author’s calculations
Table 2. Debt of State and Local Governments in Germany, end-2014
Source: Federal Statistical Office, authors’ calculations
Debt Limits, Sustainability and Preventing Bail-Outs
The effective (legal and illegal) subnational debt is influenced by many factors. Among these are the legal rules for borrowing and repayment terms, the theoretical background applied in the specific system of fiscal federalism, and the institutional settings for supervision and sanctions. Subnational governments in both China and Germany are currently looking for ways out of their financial crisis respectively, with more sustainable financing of public expenditures. Both are facing the goals of increasing, maintaining and securing economic growth that crucially depends on efficient infrastructure investments with sustainable financing profiles. Therefore, a working concept of ‘sustainable’ public debt is crucial for the long-term growth and economic competitiveness in both countries.
China and Germany both have attempted to address subnational borrowing recently at the state/provincial level, albeit in different ways. China has permitted the issuance of bonds at the provincial level within limits, whereas Germany has introduced a balanced budget rule for the Länder, moving towards the situation that used to operate in China. What both countries have in common is the absence of effective own-source revenue handles at the state/provincial level. These raise questions about the incentive compatibility and credibility of the reform measures in both cases, given major imbalances in the structure of intergovernmental fiscal relations.
The spending pressures and absence of own-source taxes generate incentives for provincial/state political decision-makers to cover costs by “hidden” borrowing. This is often through public enterprises and public-private partnerships (PPPs) which are able to borrow for investment purposes (financial leasing, federal highways, economic projects, reconstruction of public buildings, etc.). While the data may not be reflected in the official statistics, in fact tax-payers continue to carry the financial risks over the medium-term. Therefore, in both countries the recent data on subnational public debt are incomplete.
The lack of transparency generates the risk that capital markets may overestimate the true dimension of future payment obligations and start speculating against the governments—as was the case during the Euro debt crisis. However, there are other problems related with poorly quantified subnational public debt. These include the effectiveness of comprehensive debt limits, the political economy of preventing bail-outs, and the need for risk management in national and/or international capital markets. Public debt regulations must include valid and controllable debt limits, which are accepted by the public on the one hand and rules for cases of bail-out situations on the other hand, in order to prevent these from occurring or limit damage for the whole public sector and/or the economy.
Risk Management and the Capital Market
The budgetary risks if public debt is too high can create turbulence in the capital markets. These risks are common, as seen recently in the EU countries during the crisis (Ahmad et al. 2016). One of the main risks, compounded with weak recording and monitoring of liabilities (Ahmad 2016) is that public liabilities can accumulate unnoticed in the balance sheets of banks and financial institutions, hidden by often unrealistic valuations of asset prices, particularly property.
An important share of local debt in China is still held by the so-called shadow banks. The term shadow banking refers to banks that operate outside the formal banking system and is defined as the system of credit intermediation that involves entities and activities outside of the regular banking system in a broad sense. There are many risks associated with shadow banking systems, since they are not regulated financial institutions. The most significant risk stems from the leverage that they are able to operate by not holding as much in reserves as traditional banks.
Chinese local government have intensively used special instruments, so-called local government financing vehicles (LGFV), for funding local infrastructure projects for many years. This hidden local debt were mostly borrowing short-term funds that accumulated an increasing amount of repayments from year to year.
Despite the developed capital market in Germany, in a mid or long run, all subnational governments bear considerable budgetary risks from their high debt. Will the homogenous rating of all German governments continue despite the tremendous differences of public debt of states and local governments? Will the highly indebted local governments succeed in balancing their accrual accounts and maintain positive equity capital? Will the debt-relief pro-grams for local governments in many Länder, which each cost several hundred million Euros, lead to the reduction of illegal cash loans? Although, local governments have no problems finding adequate offers for loans and other credits from privately owned financial institutions, will the public-owned banks be able to pitch in when European financial markets regulations become tighter?
A 1931 law prevents local insolvency. Local property, needed for the provision of constitutional mandated local goods and services, cannot be impounded. It is unclear until today whether the States are liable for excessive debts of their municipalities and counties. State governments carefully try to prevent highly indebted communities going to the State Constitutional Courts in order to transfer a share of their local debt to the States. In recent years, experts report that many small communities had problems to renew their loans from private banks; and state-owned banks offered new credits. This breaches any “no-bailout” criterion for hard budget constraints and opens up a tendency for bargaining in relation to sub-national debt.
Recent reforms
The recovery of the global economy has helped to stabilize subnational governments’ revenues. China and Germany differ only at the first view with concern to subnational public debt. It is remarkable that China has started to legalize borrowing at the provincial level and an annual ceiling is set. The majority of the provincial LGFVs were transferred into loans while in total subnational public debt has been still growing up to 16.6 trillion RMB by November 2017. In contrast, Germany requires balanced budgets at the state level from 2020. It is noteworthy that the debt brake at the intermediate level was needed to reinforce fiscal prudence in Germany, given the absence of own-source revenues at this level, a positive limit was seen as infeasible. Since 2012, German States have reduced their total debt by about 10%, which be the end of 2017 only amounted to 17.7% of GDP.
At the prefectural, county and city level in China, public debt continues to be illegal. German local governments (cities, villages and counties) carry forward the traditional rules and limits for local debt permitting borrowing for investment financing as long as the communities are able to service interest payments and the mature redemptions. The regulations in both countries obviously counter-balance each other. Particularly the requirement of balanced budgets and the formal ban of borrowing stand in opposition to the ‘golden rule’ of investment finance according to which the costs of the long lasting infrastructure should be transferred to the benefitting taxpayers’ generations. Both countries obviously lack a true theory of sustainability and a practice of transparent borrowing transactions, which clearly identifies the risks for future taxpayers.
The most important problem in both countries obviously is that subnational governments do not respect the regulations and interdictions of public debt. Official data, although improved and enlarged in the recent years, do not provide a true picture of public debt. There are numerous loopholes in both countries concerning forms of debt or de facto-debt, which are not counted in the debt statistics. The ban on borrowing or debt limits which conflict with the specific political rationality of the governmental decision-makers seems to generate an incentive to creatively evade the officially stipulated subnational debt. In both countries, there are incentives to push down the liabilities to municipalities with more complex instruments, like PPPs, so that they are harder to identify and control. In China, the volume of subnational PPPs has reached 17.8 trillion RMB by the end of November 2017. German subnational governments prefer more hidden forms of contracts or shift borrowing activities to their state-owned enterprises, which do not count among the public sector statistics.
In both countries, the problem, which has caused the critical development of subnational public debt is unsolved: a heavy burden of unfunded mandates on the one hand and insufficient own tax revenues of the other hand. And decentralized tasks like education, internal security, and development and modernization of infrastructure become more and more important being threatened to be swamped out by unfunded mandates. Therefore, the expansion of subnational public debt will continue unnoticed, adding to systemic risks and eventually become a burden for future generations.
References
Ahmad, E. (2016). Political economy of information generation and financial management for subnational governments: Some lessons from international experience. In E. Ahmad, M. Bordignon & G. Brosio (Eds.), op cit.
Ahmad, E., Bordignon, M., & Brosio, G. (2016). Multilevel finance and the eurocrisis. Edward Elgar.
Chinese National Audit Office (2013): National Auditing Report on Local debt.
Newsletter n. 9 | May 2018 - download pdf
