Sara Hsu
Sara Hsu

President Xi Jinping entered his tenure with a clear commitment to reform. But slacking economic growth might jeopardize that promise, writes analyst Sara Hsu in the Diplomat. One main reason: central and local governments have very different interests.

Sara Hsu:

One reason that the leadership is in such a bind with local governments is that fiscal imbalances between the central and local governments have still not been corrected. Local governments have been desperate for sufficient revenue to cover their massive expenditures on social services and infrastructure and continue to face no reprieve. The recent fiscal reform appears to have even skewed revenues a bit more in favor of Beijing, as service enterprises will switch from paying the business tax, which generally goes to local governments, to the VAT tax, which is transferred to the central government.

Another reason why local governments were allowed to use LGFVs is because the attempt to expand the municipal bond markets was insufficient. Local governments rolled out 400 billion RMB in 2014, which proved insufficient to finance local government projects. Land sales have also slowed, resulting in smaller revenue intake.

China needs additional fiscal reform, particularly with redistribution from central to local coffers, but this is unlikely to happen as both central and local government are pressed for funds to stimulate growth and implement reforms. Certainly the leadership has a challenging road ahead. The reversal on local government debt channels is just one harbinger of obstacles to come.

More in the Diplomat.

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