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Local governments' newfound frugality hits growth

TOKYO -- China's slowdown could be sharper than generally expected as local governments, long the principal driver of the country's economic growth, curb spending.

     Shanxi Province exemplifies this trend toward fiscal rectitude among China's local governments. Its economy grew only 4.9% last year, the slowest expansion among all provinces.

     The Shanxi government's annual work report cited "shortcomings on the policy front" in the province, but few observers take these words at face value.

     Shanxi's growth rate plunged four percentage points from the 8.9% logged in 2013. Changes in the economic environment and failed policy responses alone cannot explain such a sharp slowdown.

     The main factor was the provincial government's move to rein in its spending, itself a response to the central government's call for policy adjustments to a "new normal" for the world's second-largest economy. Beijing, it seems, is getting serious about dealing with the country's ballooning local government debt.


For years, local governments across the nation have been pumping up economic growth through massive infrastructure investment using money provided by so-called local government financing platforms, or infrastructure investment funds.

     The result is a pyramid of local debt that is posing an increasingly serious threat to the nation's financial system.

     With concerns about a full-scale debt crisis on the rise, the administration of President Xi Jinping has decided to step in, telling provincial and other local governments to adjust their economic policies to reflect the new reality of the Chinese economy. By changing local governments' mindset, Beijing hopes to bring an end to their debt-fueled spending spree.

     This has produced strong and instant effects on local government policies.

     The governments of 31 of the highest-level local administrative divisions -- provinces, direct-controlled municipalities and autonomous regions -- announced economic growth targets for 2014. Only one, the Tibet Autonomous Region, met its target.

     Tibet has kept its growth target unchanged for 2015, but 29 other local governments have lowered theirs substantially. The city of Shanghai has decided to stop announcing a growth target altogether.

     The targets set by Shanxi and Liaoning provinces are 6%, down three points from their 2014 goals. They are also lower than the central government's growth target for the entire Chinese economy, which has been set at "around 7%."

     Provincial and municipal governments once strived to engineer local growth that was faster than that of the national economy, but those days are over. The time for fiscal belt-tightening in China has come.

Political incentive

The chief executives and senior bureaucrats of local governments were eager to achieve outsized growth because their promotion within the Chinese Communist Party was tied to the economic performance of their districts.

     In evaluating its employees' job performance, the government of Shenyang, the capital of Liaoning Province, used to put the greatest weight on "contribution to gross domestic product." But the municipal government reviewed its evaluation criteria in 2014 and decided to attach greater importance to such factors as the employment rate, food safety and public hygiene.

     The central government's shift toward focusing on fiscal health is prompting local governments to follow suit. The question is what fallout this mass movement toward fiscal austerity will bring.

     A ban has been imposed on borrowing by local government financing vehicles, which means their only fundraising option now is issuing bonds. But a revision to the budget law in January has imposed restrictions on local government's bond issuance.

     This situation could spell a recession-inducing crisis reminiscent of the "fiscal cliff" in the U.S. -- a combination of tax increases and across-the-board spending cuts scheduled to take effect after Jan. 1, 2013 -- that roiled global markets at the time.

     China is likely to face its biggest fiscal problem since 1981, when the country's economic reform began in earnest, warned Zhang Zhiwei, chief China economist for Deutsche Bank.

     The local debt burden and other economic challenges are making it difficult for China to achieve even the government's more modest target of 7% growth.

      "China is at a critical juncture where it needs to decide whether to abandon the high-growth policy it has been maintaining since the era of Deng Xiaoping," said Yuji Miura, a senior economist at the Japan Research Institute.


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