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Half-built palaces and towers expose rural China's debt risk

Guizhou county saddled with billions in loans after construction spree

HONG KONG -- A man surnamed Lou, the 42-year-old boss of a travel company in the southwestern Chinese province of Guizhou, never thought his small home county would become famous this way.

The county of Dushan, meaning "single mountain," made headlines this month after a vlog titled "How Dushan Burnt 40 billion" went viral on Chinese social media.

Produced by Shanghai-based Guan Video, the 22-minute programme shows clusters of unfinished projects -- including Forbidden City-style palaces -- that the host claims have plunged the local government into a 40 billion yuan ($5.72 billion) debt hole.

For many, it is hard to imagine how an isolated, hilly area in one of China's poorest regions could secure so much financing -- equivalent to the cost of making 40 satellites for the recently completed Beidou satellite system. The video has reignited an online discussion over the depth of regional Chinese debt, which remains one of the biggest mysteries in the country's opaque system for reporting economic statistics.

Borrowing by lower-level authorities in counties, villages and towns is particularly vulnerable, experts said, as it often exceeds the revenue received by the municipality and tends to be more difficult to trace.

"If [officials] borrow a lot of money, they can build a lot of stuff that would reflect on the GDP growth of that county," said Victor Shih, associate professor at the University of California, San Diego. Strong economic growth helps officials secure promotions, Shih said.

In Dushan, a 99-meter clay building and an antique-style bell tower on top of a hill were among the ambitious tourism projects planned under the county's former Communist Party secretary, Pan Zhili.

But construction of the attractions was abruptly suspended by the end of 2018, the travel company owner Lou recalled. Pan was removed from his post shortly afterward. It turned out the government ran out of money to keep the construction going, and private investors pulled out.

Pan was arrested in 2019 and sentenced to 12 years in prison for corruption. The developments were slammed as "vanity projects" by state media and have since sat idle.

"We knew that the government was borrowing money, but we had no idea it had borrowed so much," said Lou, who has lived in Dushan since 2014. All Lou had seen was a construction spree of highways, malls and attractions since 2016. Many tea-picking farmers doubled their income thanks to the new job opportunities, he said.

Dushan's outstanding loans totaled 13.6 billion yuan at the end of June, the county said on its official website on July 16. The rest of the money was raised by corporate borrowers that participated in the projects, the statement said. Dushan's gross domestic product in 2019 was 12.6 billion yuan.

A newspaper operated by the Communist Party's disciplinary watchdog revealed last year that most loans guaranteed by the county's government had interest rates topping 10%, and its total debt had mounted to 40 billion yuan when Pan was fired.

China's tax distribution system contributes to the local borrowing problem. Municipalities keep only a small portion of tax revenue, while the bulk goes to the central government. Local officials often find the revenue and fiscal transfers from Beijing and surrounding provinces insufficient to build the public infrastructure needed to meet economic growth targets.

By law, issuing bonds through provincial governments is the only legal way for regional authorities to raise funds. But many lower-level municipalities borrow through financing companies they set up.

Some take advantage of public-private partnerships by providing government guarantees on loans that private investors raise. The scheme was introduced in 2014 to ease debt service pressure on local governments. But in reality, many governments just invite fake investors to gain approval for borrowing.

Such loans often don't appear anywhere on the government's budgets, Shih said, increasing the risk in the nation's financial system as they keep rolling over.

The International Monetary Fund estimated hidden regional government debt at 30.9 trillion yuan as of the end of 2018. China Chengxin International Credit Rating, a local agency, said the scale was 43 trillion yuan at the end of 2019. There was also 21.3 trillion yuan in on-budget local government debt -- mostly bonds -- at the end of last year, China's Finance Ministry said.

The coronavirus outbreak has amplified the risk of defaults. China's economy declined 1.6% in the first half of the year, despite a slight improvement in the second quarter. Most regional governments recorded a fall in revenue due to reduced business activities and extended requirements for fee and tax cuts.

To prevent a blowup of municipal loans, Beijing has increased the bond insurance quota, which will allow more money to be transferred to lower-level governments. In the first five months of 2020, 3.2 trillion yuan of debt was issued, up by 65.1% from a year ago.

The inflow of new funds also means local governments can continue building planned infrastructure and tourism projects.

"If China continues with its rapid economic growth, there might be a chance for the debt risks to be slowly resolved," said Wan Qian, an economist at International Finance Corp. "But if growth slows, we are likely to see more defaults going forward."

"Local governments were very optimistic," Wan added. "They thought once the infrastructure was built, tourists would come."

One bitter outcome of hidden loans is the accumulation of unsound investments with little prospects for a turnaround. In some cases, small investors were also trapped into footing the bill.

Investors lost billions of dollars after police in the eastern Chinese city of Hangzhou arrested the founder and dozens of workers at JC Group, alleging illegal fundraising activities. The company defaulted on at least 17 billion yuan by October 2018 after raising as much as 30 billion yuan from public investors through sales of hundreds of funds and wealth management products, Chinese media Caixin reported, citing the police investigation.

The company, with a subsidiary listed in Hong Kong, was known for developing "themed town" projects in rural China. Beijing rolled out a plan in 2017 to build 1,000 towns with unique features by 2020 in a bid to narrow the wealth gap between cities and the countryside.

Before the collapse of JC Group, the company claimed to have signed contracts with local governments worth 580 billion yuan for developing 59 such towns across China.

In an interview with Nikkei Asian Review back in 2018, Kelvin Wong, executive director at JC Group's Hong Kong branch, acknowledged that the strong government support was crucial in getting the resources needed to build such towns.

Alfred Wu Muluan, an associate professor in the Lee Kuan Yew School of Public Policy at the National University of Singapore argues that it is "inevitable" for many projects to languish in the long term.

"The real demand in rural areas is declining as more residents are moving to the cities," he said, and only a small number of villages and counties have the potential to draw tourists, Wu said.

But ironically, Wu said, even if some officials knew of the probable outcome, they would push ahead with the projects, hoping to get a promotion before things turn sour.

"The debts just keep growing, and no one wants to stop," he said.

Shih, the professor from the University of California, San Diego, estimates that trillions of yuan in loans in China's banking system continue rolling over as governments keep expanding balance sheets to prevent a crisis.

"Ultimately, it's paid for by the monetary expansion. The People's Bank of China just keeps printing money," Shih said. But ordinary people would have to deal with higher inflation rates and lower purchasing power.

Despite the negative press coverage of Dushan since late last year, a lot more tourists are coming to the county, to Lou's surprise. He even started seeing traffic jams at some attractions, which he never experienced during six years living there.

"Now that many projects became an internet sensation, a lot of tourists came to have a look at the famous lanwei lou [half-built buildings]," the travel company boss said.

"They want to check in and take photos," Lou said. "Maybe it's an opportunity. Perhaps we can rebrand the attractions and have them serve as a warning for the debt-fueled developments that are happening in many places in China."

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