China restricts public-private partnership projects to mitigate municipal debt risks

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14th November 2023 – (Beijing) In a move to limit the escalating municipal debt risks, China has issued a directive to local governments to suspend public-private partnership (PPP) projects identified as “problematic”. The order also replaces the existing 10% budget spending allowance for these projects with a comprehensive vetting mechanism overseen by Beijing, according to informed sources.

These new guidelines, detailed in a cabinet document circulated among local governments, policy banks, and state lenders last month, mark the first significant reform of the PPP model since its inception in 2014.

China’s local government debt rose to a staggering 92 trillion yuan ($12.6 trillion), equivalent to 76% of the country’s economic output in 2022, up from 62.2% in 2019, as reported by the International Monetary Fund.

In an attempt to curb further debt accumulation, Beijing will abolish a rule that permits local governments to allocate up to 10% of their annual public budget towards PPP projects. Instead, the government authorities will conduct an in-depth review of each PPP project. This shift follows several instances of local governments’ PPP expenditure reaching the upper limit of the threshold.

The State Council has also instructed local governments to halt “problematic projects”, identified during inspections by the National Audit Office (NAO) earlier this year. These problematic projects are typically fraught with irregularities, including situations where local government financing vehicles (LGFVs) have acted as the “private” partner, leading to excessive debt accumulation.

Furthermore, all PPP projects that have not completed the partner bidding process by February this year will be temporarily suspended. Since 2014, the PPP model has been promoted by Beijing to attract private investment into public infrastructure projects, easing the burden on heavily-indebted local governments.

However, the PPP boom has prompted concerns among authorities who claim that some local governments have exploited public-private partnerships, government investment funds, and government procurement services as covert avenues for accruing debt.

Local government debt, bloated by years of over-investment in infrastructure, bills from efforts to contain the COVID-19 pandemic, and the deepening property crisis, poses a significant risk to China’s economy and financial stability. A considerable portion of the $12.6 trillion local government debt is associated with PPP projects.

By the end of 2022, China had initiated over 14,000 PPP projects with investment values reaching 20.9 trillion yuan ($2.87 trillion), roughly equivalent to the size of France’s economy, as per a Bank of China research note.

Beijing is now intensifying efforts to mitigate the broader economic risk posed by local government debt. Regulations were issued last week by the National Development and Reform Commission (NDRC) and the finance ministry to encourage private firms’ investment in PPP projects and permit them to hold controlling stakes in some projects.

Oversight for PPP projects, including the assessment of return-on-investment and fiscal stress testing, will transition from the finance ministry to the NDRC. Local governments have been instructed to report all PPP projects to the State Council and the NDRC by November and to consider issuing special-purpose or general bonds to repay debt tied to the projects.