Economy

China Faces New Shock as Local Governments Scramble for Cash in Worsening Crisis

China’s late 1970s initiative to empower local governments fostered regional competition and investment, leading to a housing boom and substantial revenue from land sales. However, as the ongoing housing crisis unfolds, these once supportive “helping hands” have transformed into “grabbing hands,” prompting calls for fiscal reforms to address the emerging challenges, according to analysts at Nomura.

The reform and opening-up policies adopted by Beijing introduced a new era of fiscal federalism, granting local governments greater financial autonomy. This shift stimulated market growth and regional competition, contributing significantly to the country’s economic expansion over the last four decades.

During the peak of this boom in 2021, land sales generated a remarkable RMB8.7 trillion, accounting for 7.6% of the GDP that year. However, the current housing crisis has severely impacted land sales revenues, resulting in increased debt pressures for local governments, which are struggling to secure funds for essential operations and employee salaries.

Nomura highlights that many local governments, previously viewed as “helping hands” promoting growth, have begun resorting to excessive fees, frequent fines, and rigid tax collection practices, effectively evolving into “grabbing hands.” This transformation poses a threat to the very foundations of China’s economic success.

Despite the challenges, history suggests that just as the era of fiscal decentralization fueled considerable growth, reform could once again provide a pathway out of the current economic difficulties. However, the analysts stress that attention must first be directed towards addressing the actions of the “grabbing hands.” They recommend that the central government allocate direct funding to stabilize the property market and enhance fiscal transfers to local authorities.

By alleviating the housing crisis, it may be possible to implement long-term solutions, such as streamlining the fiscal system, tying transfers to local growth, restricting the size of local governments, and reinforcing the rule of law, all aimed at revitalizing fiscal federalism in the wake of the housing crisis.

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