$23 trillion-plus & counting: Will China’s surging local government debt crisis affect its global ambitions?

China’s global ambitions have soared since the start of the 21st Century, decades after the country embarked on a remarkable journey to transform its closed economy into an export-driven economic powerhouse. Much of China’s global ambitions hinge on its grand policy — the Belt and Road Initiative (BRI). This policy, formulated in 2013, is an amalgamation of infrastructure projects covering Asia, Europe and Africa.

But considering BRI as just another global infrastructure plan will be like missing the forest for the trees. It involves President Xi Jinping’s grand plans to reclaim China’s past glory and shift the centre of geopolitical power from Europe to Beijing. Nevertheless, as lofty as it may seem, BRI has left a debt trap of $1 trillion for 150 – mostly developing – countries.

China’s BRI-induced debt trap has brought countries to the brink of bankruptcy – anyone remembers Sri Lanka, Pakistan and Kenya? All these countries owed a substantial part of their debt to Beijing.

However, ongoing domestic development will likely be a speed-breaker to China’s global ambitions.

China’s domestic debt problem

Years of infrastructure-driven growth helped China connect every part of its expansive geography, create clusters of urban industrial centres and accelerate economic growth that was only paralleled by the US in the late 1800s and early 20th Century. But that itself is proving to be China’s undoing.

According to economists at Goldman Sachs, China’s local government debt could be over $23 trillion. That’s about seven times the size of India’s Gross Domestic Product.

For the uninitiated, local governments play a huge role in China’s economic planning. They include the provincial, county and municipal administrations, which fund most local infrastructure projects.

While China has been on a decentralisation spree for many decades, 2015 was a watershed year for local governments. That year, the Chinese government amended the Budget Law to allow local governments to raise funds from the open market by selling bonds. While the amended law now gives the local government more power to finance projects, the various qualifying conditions have made it a not-so-popular funding source.

To circumvent the limitations of municipal bonds, local governments in China stuck around with the age-old Special Local Government Finance Vehicles (LGFVs) model. These organisations have been opened across the world’s second-largest economy to finance major infrastructure projects.

The debts incurred by LGFVs are considered “hidden” as the local governments do not report them. Since LGFV debts are off the accounting books, local governments have time and again misused them to finance unsustainable projects. This has resulted in a ballooning debt crisis.

The reports of shanty towns or ghost towns with numerous unfinished highways, housing projects, and tourist attractions that the world keeps hearing are prime examples of local governments failing to sustain infrastructure projects due to high indebtedness.

For several years, local governments had it easy as the Chinese realty market boomed and local governments were able to generate revenue. But once the realty sector began weakening – remember realty giant Evergrande and its $300 billion debt? – in 2021, the repercussions have been unprecedented.

The true size of China’s debt mountain can only be calculated when one adds the total local government debt with the realty and household debts — there is a significant overlap between the three.

Factor this: China’s total debt is now more than the average in developed countries. It’s much higher than the US, frequently grabbing headlines for its high indebtedness.

According to market analysts, China’s debt is 282 per cent of its annual economic output, which is way higher than the developed world’s average of 256 per cent. The ratio is 257 per cent for the US, China’s arch-rival.

Impact on China’s ‘debt trap diplomacy

Given China’s opaque statistical practices, the mystery around the exact debt figure is likely to be solved. Whatever the real debt figure, the repercussion can already be felt in China’s predatory debt practices.

A New York Times report suggests that total lending to other countries is a mere six per cent of China’s annual economic output. However, the ticking debt time bomb at home is making China’s financial institutions not accept losses on their foreign lending, especially those made to low-income countries.

The first signs of China’s unwillingness to ease debt repayment conditions for poor conditions could be seen in 2022. This was a year after the realty sector showed its first signs of weakness, and the country, entered an extended period of Covid lockdown.

A recent Reuters report shows that Beijing – the world’s largest bilateral creditor – forgave $19 billion in 2021, but that figure dropped to $9 billion in 2022 and $1.7 billion by April 2023. This massive drop hints at China’s fears that going slow on debt repayments will help the indebted nations but can backfire on its economy.

But China’s growing international stature under Xi allows the country to stay on being a top global lender. It does not help China’s cause that it is locked in an ongoing geopolitical tussle with the United States.

It is tough being in China’s position right now. It must keep its position as a top lender to compete with the West. But Beijing will need to renegotiate loans to mollify debtors, as it has done with a few countries like Zambia.

However, this will also mean China is losing out on timely debt repayments.