China faces new shock as local governments scramble for cash, worsening crisis

Investing.com — China’s move to free the reins on local governments in the late 70s was once a source of strength, prompting regional competition and investment that sparked a housing boom and hefty revenue from land sales, but now as the housing crisis rages on, those “helping hands” have shifted to “grabbing hands,” Nomura says, prompting a need for fiscal reforms to curb this second wave of shocks.

Beijing initiated reform and opening in the late 1970s, ushering in a wave of fiscal federalism — which provided fiscal autonomy to local governments, promoted market development and facilitated regional competition — and supercharged the country’s growth over the past four decades.

“In the boom years, hefty revenue from land sales, analysts at Nomura say, “enabled local governments to play the role of ‘helping hands’ by promoting growth and attracting business under the performance-based promotion system.”

At its peak in 2021, total revenues from land sales reached RMB8.7 trillion, or 7.6% of that year’s GDP.

But the housing crisis has put a major dent on land sales revenues and debt pressures have escalated, sending local governments scrambling for cash to maintain basic operations and wage payments.

Against this backdrop, a rising number of local governments once considered “helping hands” in promoting growth, Nomura says, have now become “grabbing hands” by charging exorbitant fees, imposing frequent fines and excessively strengthening tax collection.”

This shift, Nomura warns, undermines “the foundations of China’s economic success story.”

But just as the once-golden era of fiscal decentralization proved the touchpaper that sparked strong growth, reform, once again, may help China out of this economic quagmire.

But first those “grabbing hands” need to be addressed, the analysts say, calling on the central government to provide direct funding to stabilize the property market and increase fiscal transfers to local governments.

Dousing the flames of the housing crisis would likely pave the way to longer-term solutions including “streamlining the fiscal system, linking transfers to local growth, limiting the size of local governments, and promoting the rule of law to rebuild fiscal federalism in a post-housing crisis era,” they added.