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China’s ULB debt crisis reveals what Indian cities must avoid while building infrastructure and chasing growth.
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This is the 172nd in the China Chronicles series
A key element of China’s spectacular economic growth was the immense infrastructural push country’s local governments—comprising provincial governments and urban local bodies (ULBs). This was enabled by fiscal policy support from the Chinese government and an investment environment that allowed local governments (LGs) to use debt instruments to finance infrastructure and propel local economic growth.
However, the debt-driven strategy led to asymmetry: economically weaker LGs, in regions with lower Gross Domestic Product (GDP) growth, often borrowed more heavily than those in relatively prosperous economies. Nonetheless, irrespective of their economic standing, most LGs generously dipped their hands into debt piles.
The debt-driven strategy led to asymmetry: economically weaker LGs, in regions with lower Gross Domestic Product (GDP) growth, often borrowed more heavily than those in relatively prosperous economies. Nonetheless, irrespective of their economic standing, most LGs generously dipped their hands into debt piles.
The primary debt instrument they used was the Local Government Financing Vehicles (LGFVs)—market-oriented, state-owned investment companies tasked with raising debt on behalf of LGs. LGs were liquidity-constrained and had little capacity to borrow on their own balance sheets, primarily due to Beijing’s 1994 fiscal reforms, which reduced their share of tax revenues from around 78 percent to about 50 percent. Instead, they turned to LGFVs to raise funding for infrastructure investments to meet government growth targets. Although this fiscal arrangement promoted monetary circulation, ULBs could not borrow on their weak balance sheets and, in turn, had to borrow from outside—rendering the debt opaque with serious, negative financial consequences.
The modus operandi worked like this: LGs granted their land parcels to LGFVs at no cost. LGFVs would then sell these to developers or use them as collateral to raise debt via bonds they were empowered to issue. The money raised was invested in infrastructure projects, contributing to local GDP growth. However, many infrastructure projects ended up being unproductive, lacking proper economic analysis or feasibility. For example, Guizhou—one of the poorest provinces in China—constructed over 1,000 new bridges, many of them engineering marvels. Unfortunately, several of these bridges were unnecessary and failed to contribute to the local GDP or deliver any economic returns.
Borrowings surged alongside Beijing’s booming real estate market and attractive land values. The revenue for the LGs from the land lease sales increased from ¥3.84 trillion in 2016 to ¥8.71 trillion in 2021. However, as the real estate market collapsed, the demand dipped post-2021, and revenue inflows for LGs fell sharply. LG revenues fell to ¥6.69 trillion in 2022 and ¥5.54 trillion in 2023. Simultaneously, the bonds issued by LGFVs began to mature, raising the repayment burden from ¥3.3 billion in 2014 to ¥4.7 trillion in 2024. The LGs clearly had taken on unsustainable debt and could no longer meet their repayment obligations.
Despite these challenges, the Chinese government has maintained a strong grip on the country’s financial architecture. Central authorities are trying to manage the crisis by restructuring the debt, rolling over bonds, and eventually paying them off. President Xi Jinping recently emphasised that it was necessary ‘to consolidate the responsibility of provincial-level governments to prevent and resolve hidden debts, increase efforts to dispose of outstanding debts ……… and resolutely curb the increase of hidden debt.’
Official estimates of the total LG debt burden of LGs are difficult to assess, as most were not reflected on the official balance sheets. Goldman Sachs estimates it at around US$ 8.5 trillion; the International Monetary Fund (IMF) pegs it closer to US$ 10 trillion. The consequences of unsustainable debt are now visible. In Hegang, a million-plus prefecture city in China, internal heating has been suspended, public school teachers are losing jobs, and sanitation workers remain unpaid. Similar distress prevails in Heilongjiang, Henan, Hubei, Guizhou, and Guangdong, with all suffering from the consequences of debt distress, including the provincial governments and ULBs.
Despite these challenges, the Chinese government has maintained a strong grip on the country’s financial architecture. Central authorities are trying to manage the crisis by restructuring the debt, rolling over bonds, and eventually paying them off. President Xi Jinping recently emphasised that it was necessary ‘to consolidate the responsibility of provincial-level governments to prevent and resolve hidden debts, increase efforts to dispose of outstanding debts ……… and resolutely curb the increase of hidden debt.’ While China has already taken steps in this direction, the potential of this mountainous pile of local debt to decelerate their national economy can scarcely be denied.
Indian ULBs have much to learn from this experience.
First, Indian ULBs can become powerful engines of economic growth and urbanisation. Their contribution to the national GDP has stagnated at around 60 percent. This can rise sharply if the national and state governments provide ULBs the necessary financial instruments and the freedom to leverage their assets to raise money in the market. However, this must be done on the strength of their balance sheets—not off them. For this shift to occur, the Government of India must substantially increase its financial support to ULBs. It is plain that markets do not respond to entities with poor credit ratings and low repayment capacity.
Second, building infrastructure without assessing its economic contribution is counterproductive and inflationary. While Indian cities have enormous infrastructural scope, building unnecessary infrastructure leads to wasteful expenditure and inflation, thereby warranting serious curbs.
Third, debt ceilings are essential. Borrowing must be kept within sustainable limits, and there must be clearly defined rules governing how much a ULB can borrow and under what conditions.
That said, these above-cited caveats still cannot negate the fact that China has made excellent mobilisation of local governments in creating world-class infrastructure and providing a huge thrust to urbanisation. While the pitfalls in the process indicate a care regime that ought to be installed, it must be admitted that ULBs have a massive role in nation-building. The Government of India and the state governments need to build the strengths of their ULBs and engage in robust, all-around partnerships with them in the economic growth of this nation.
Ramanath Jha is a Distinguished Fellow at the Observer Research Foundation.
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Dr. Ramanath Jha is Distinguished Fellow at Observer Research Foundation, Mumbai. He works on urbanisation — urban sustainability, urban governance and urban planning. Dr. Jha belongs ...
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