In October, Beijing announced that four city and provincial governments – Shanghai, Shenzhen, Zhejiang and Guangdong – would be allowed to start issuing bonds for the first time in China’s history. Zhejiang is expected to issue $8 billion yuan in bonds, including half three-year bonds and half five-year bonds. The proceeds are intended to fund infrastructure projects already under construction.
But why now? What was the impetus for this unusual step?
Quite simply, it’s a financial pacifier – recent central government policies aimed at cooling down real estate have hurt local governments, who rely on land sales and development fees as their most important sources of revenue. As these revenues fall, local governments will become increasingly desperate to find other means to finance infrastructure projects and social services.
Real estate has certainly been a boon for local governments. Land revenue, garnered from a variety of fees and taxes, is particularly attractive because it’s considered extra budgetary income, which isn’t counted in the central government’s accounting of local government budgets and thus can be kept and used with no strings attached by local governments. As a result, the revenues coming from commercial and residential land leasing and sales have become the most important source of local revenue, accounting for 30 percent to 50 percent of rural government revenues, and 50 percent to 60 percent of city government revenues.
Real estate has also made a difference to local officials politically: local officials are evaluated for promotion based heavily on the rates of growth in their jurisdictions, as well as the amount of revenue they collect and their revenue contributions made to higher levels of government.
Land transfer fees form another crucial piece of the pie: in 2007, land transfer fees were 67 percent of Sichuan Province’s local revenue, and 40 percent of Chongqing’s. In 2010, land transfer revenues totaled 3,000 billion RMB ($464 billion), which was more than 70 percent of local government revenues. This year, HSBC estimates that land transfer revenues will be less than 2,000 billion RMB.
Clearly, local governments depend heavily on revenue from land sales, transfer fees, and other real estate-related fees and taxes. Now, after years of gangbuster growth, central government policies aimed at avoiding a bubble burst have dampened the real estate market.
Property prices have finally begun to slow this autumn, with average property prices in a 70-city index seeing their first monthly decline in several years. In addition to the impact of the current slowing, there also remains the possibility that the real estate bubble could burst.
Unlike the U.S. bubble, a bubble burst in China wouldn’t spell doom for the homeowner – in China, real estate investment is a vehicle for saving, not borrowing, and required down payments are 30 percent to 40 percent, limiting debt levels. Instead, local governments will take the brunt of the slowdown or bubble burst as result of their heavy reliance on real estate revenues.
As mentioned, local governments will experience a significant loss of revenue, and not just from a decline in land sales: local governments also rely on income from construction and the production of raw materials that goes into construction.
In 1994, fiscal decentralization reformed China’s revenue sharing system, effectively reducing local governments’ share of the central revenue stream while increasing their responsibility for providing social goods.