Squeezing the provinces

CHINA ADVISORY - Report 21 Jan 2022 by Andrew Collier

The Evergrande default and the property crackdown show a new willingness by Beijing to force deleveraging even as the economy slows in order to avoid a financial crisis. The main solution to the Evergrande default is to force debt workouts onto the backs of provincial governments. This is part of a longer trend under Xi Jinping to centralize political power but decentralize fiscal responsibility to the lower levels of government – I call this "squeezing the provinces". Investors are expecting a centralized solution to China’s economic decline but so far we have seen only modest changes, including lowering the Require Reserve Ratio and cutting interest rates. Massive stimulus has yet to come. If local governments can absorb the pain of some unemployment, Beijing may avoid reinflating the economy.

The three red lines property policy and the Evergrande default have highlighted the importance of local government financing and financial capacity. Beijing has shown a surprising tolerance for economic tightening for more than a year – since the Three Red Lines forced developers to retrench way back in August 2020. The rules were relaxed a tiny bit in January 2022 but only by allowing developers to exclude debt raised to buy distressed assets of another developer – pretty modest. Meanwhile, the local governments have been frantically trying to raise more cash through the sale of land and by increasing whatever modest taxes they already impose on small businesses. But it has been difficult.

As a result of all this tightening, the conventional wisdom has been that Beijing will step in with a massive stimulus in 2022. We have yet to see that happen (although the announcement on January 19 of a 32 percent increase in rail construction by 2025 was interesting – it is doubtful this will be fully funded). What many analysts fail to understand is that Beijing has quietly been squeezing the provinces for much of Xi Jinping’s tenure. The property debacle is just the latest strand of this policy.

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