China debt crisis: Xi Jinping unveils plans for $9 trillion problem

China’s top leader mapped out measures for fixing the debt crisis facing regional authorities in a near-22,200 character resolution published by the official Xinhua News Agency on Sunday. Those plans centered around shifting more revenue from the central to local coffers, such as by allowing regional governments to receive a larger share of consumption tax.

Xi’s proposals mark the “third major taxation and fiscal reform” in recent history, said Ding Shuang, chief economist for Greater China and North Asia at Standard Chartered Plc. He cited the 1994 move to increase central governments’ share of revenue over regional authorities, and a string of decisions starting in 2013 that allowed localities to issue bonds on their own, as the other major shifts.

“The central government’s income was set too high and now it’s being adjusted,” Ding said of the framework set under then President Jiang Zemin. The changes “will alleviate the imbalance between the central and local government’s spending responsibilities and income,” he added.

Xi presided over a twice-a-decade conclave in Beijing this month, where some 400 senior officials endorsed his vision for advanced manufacturing to propel China’s $17 trillion economy. The resolution from that conclave signaled that while the top leader is fine-tuning policies to manage risks, no major shifts are afoot in his overarching plans. 

Chinese policymakers are under pressure to resolve local governments’ 66 trillion yuan ($9.1 trillion) hidden debt crisis and rebalance the economy, as foreign leaders accuse Beijing of using exports to compensate for weak demand at home. Giving a larger portion of consumption tax to regions could address both issues by incentivizing officials to lift consumer spending and offering them a new finance stream.

Slapping additional taxes on goods, however, risks stifling sentiment further among Chinese consumers already reluctant to spend due to a property slump that’s hitting their primary store of wealth. Retail sales rose at the slowest pace last month since December 2022, as China’s second-quarter growth figures undershot expectations.

Officials also pledged to give city governments more autonomy in regulating local property markets, in line with policies over the past two years that allowed localities to better arrest the housing downturn. They also vowed to build more subsidized housing, as well as reforming the pre-sale model, which has led to developers being unable to deliver millions of homes already paid for by residents.

China’s most-powerful leader since Mao Zedong said in a separate explanation that national security had been put in a “more prominent” position by the four-day conclave, suggesting its preeminence over the economy. The official resolution, however, stated Beijing would strive to “achieve positive interactions” between development and security. 

Officials also signaled a potential expansion to Beijing’s surveillance architecture, vowing to “explore and establish a national unified population management mechanism.” That marked the first use of that phrase by senior leaders. 

“Xi’s emphasis on security shows that the development is eventually aimed at protecting national security,” said Alfred Wu, an associate professor at the National University of Singapore’s Lee Kuan Yew School of Public Policy.

Investors may find their hopes were too high for the Third Plenum, he added, noting the report was mostly “sprinkling” vague measures rather than signaling concrete changes.

Markets reacted poorly to the lack of policy signals in an initial communique published after the gathering wrapped Thursday. More specific policies could be unveiled later this month by a meeting of the 24-man Politburo which focuses on economic policies for the year in July. 

Xi last used the Third Plenum to chart economic reform in 2013, when investors were waiting for the new president’s long-term vision to become clear. The top leader has since consolidated power with a precedent-defying third term and well-telegraphed his vision for weaning the nation off boom-and-bust debt cycles. That was reflected in the resolution, which served as a continuation of his long-term vision. 

Advancing “high quality development” featured prominently in the report — a vague slogan typically interpreted to emphasize the quality of economic growth over its absolute pace. It centers on Xi’s ambitions to propel China’s economy by moving up the value chain through tech innovation.

China will also strive for “revolutionary breakthroughs in technologies,” top leaders said, vowing policy improvements for developing sectors including artificial intelligence, new materials and quantum technology. The nation also pledged to develop more controllable supply chains for areas including integrated circuits and advanced materials.

Developing chips and AI is central to Beijing’s broader vision of replacing technology from the US, which is increasingly trying to ring-fence China. Economists have listed technology self-sufficiency as among the top three economic issues Chinese leaders must tackle in the medium-to-long term.

“I think the third plenum did not change the government’s policy objectives,” said Zhiwei Zhang, president and chief economist at Pinpoint Asset Management, “but it introduced new measures to achieve such objectives.”