China faces a funding gap of nearly $1 trillion. It will take more debt to fill it.

In the first four months of the year, investments in real estate development fell by 2.7% compared to the previous year. Pictured here is a project in Qingzhou, Shandong province, on May 15, 2022.

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BEIJING – The Chinese government is facing a growing liquidity shortage, analysts say, as they forecast a rise in debt to fill the gap.

“The recent Omicron wave and widespread lockdowns in place since mid-March have led to a sharp drop in government revenue, including revenue from land sales,” Ting Lu, Nomura’s chief China economist, and a team said in a report last week.

They estimate a funding gap of about 6 trillion yuan ($895.52 billion) — about 2.5 trillion yuan in lost revenue due to tax rebates and weaker economic output, and another 3.5 trillion yuan in lost revenue from land sales.

“Many of the incoming ‘stimulus measures’, whether it be special government bonds or incremental lending by political banks, are being used simply to fill this funding gap,” the Nomura analysts said.

They expect the 3.5 trillion yuan figure to be hard to fill, and they listed several measures, from using tax deposits to increasing borrowing, that could be used to make up the deficit.

Economic data for April showed weaker growth as Covid controls took their toll. Premier Li Keqiang said during a rare nationwide meeting last week that the difficulties are in some ways greater than in 2020.

Even before the recent Covid outbreak, land sales, a major source of local government revenue, have plummeted after Beijing cracked down on real estate developers’ heavy reliance on debt. Local governments are also responsible for implementing tax cuts and rebates announced by Beijing to support growth.

The Japanese bank and analysts at other companies didn’t share specific figures on how much additional debt might be needed. However, they pointed to growing pressures on growth, which would require stronger debt support.

Excluding tax cuts and refunds, the Treasury said local tax revenues rose 5.4% year-on-year in the first four months of the year. Eight of China’s 31 provincial-level regions saw tax revenue declines during the period, the ministry said, without naming them.

Incomplete data from Wind Information for the period showed that the regions of Qinghai, Shandong, Liaoning, Hebei, Guizhou, Hubei, Hunan and Tianjin recorded a year-on-year decline in tax revenue in the first four months of the year. Tianjin was the worst, down 27%.

Tibet was the only provincial-level region to see a drop in tax revenue in 2021, according to Wind.

It’s “important to note that the drop in tax revenue didn’t just happen in the lockdown cities,” said Zhiwei Zhang, president and chief economist at Pinpoint Asset Management.

“Many cities with no omicron outbreaks also suffered as their economies are linked to those currently in lockdown,” Zhang said in an email in mid-May. “The economic cost isn’t limited to a few cities, it’s a national problem.”

Shenzhen sees a slump in tax revenue

Since March, mainland China has been trying to control its worst Covid outbreak in two years with home bans and travel restrictions in many parts of the country, particularly Shanghai and the surrounding region.

Though financial data for many Chinese cities is not readily available, southern tech hub Shenzhen released figures showing a 44% year-on-year drop in tax revenue to 25.53 billion yuan in April. That followed a 7% year-on-year decline in March to 22.95 billion yuan.

“Local governments are under increasing fiscal pressure. Your expenses are increasing, but income is decreasing,” Zhang said. “Land sales have also fallen sharply. I think central government may need to revise the budget and issue more debt to help local governments.”

Back in March, Beijing announced an increase in money transfers from the central government to local governments. When asked in May whether this would be expanded, the Treasury noted that some funds would be frontloaded for next year to help local governments with tax refunds and cuts this year.

Pressure to invest in infrastructure

For Susan Chu, senior director at S&P Global Ratings, she’s more concerned about the deficit, the decline in revenue versus spending. Land sales don’t create deficit pressures, she said, noting that “more pressure will come from infrastructure spending and the allocation of tax cuts.”

A “growing deficit means there’s a chance of more borrowing or debt load going forward,” Chu said in a phone interview earlier this month. Though she doesn’t expect off-budget lending to come back, she said it’s an important signal to gauge risk.

In late April, Chinese President Xi Jinping called for a nationwide push to develop infrastructure ranging from waterways to cloud computing infrastructure. It was not clear on what scale or time frame the projects would be built.

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“One consequence of this this year will be less money left over for infrastructure spending,” Jack Yuan, VP and senior analyst at Moody’s Investors Service, said in a phone interview earlier this month.

He said that since land sales are a major source of local government spending on infrastructure, a decline in land sales and a limited increase in special bonds would limit financing options for infrastructure spending.

“We expect debt will continue to rise this year due to these economic pressures,” Yuan said, noting it remains to be seen how Beijing will decide to balance economic growth with debt this year.

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