BOFIT Viikkokatsaus / BOFIT Weekly 2016/35

China’s government announced last week that it was launching a reform to clarify the division of duties and reduce overlaps in them between the central government and local governments, as well as shift some local government tasks to the central government. The reform, which seeks more effective use of public funds, will proceed stepwise and it should be fully implemented in 2020. The need for public administration reform has long been apparent. The current system, introduced in 1994, dedicates 85 % of public spending to provincial and municipal levels, even if these tiers only collect slightly more than 50 % of public revenues. Even if the imbalance is largely covered by massive transfers of central government funds to provinces and municipalities, sale of land use rights has become a major revenue source for local administrations. Many see that imbalance between revenues and spending has fuelled the current indebtedness of local governments through creation of off-budget investment vehicles.

The last big public finance reform in 2014 involved letting provinces and municipalities issue their own bonds with central government approval. The change was supposed to subdue off-budget activity of local governments and improve transparency. While the 2014 changes have yet to be fully implemented, regional bond issues have increased substantially. Off-budget activity, however, remains substantial.

Official figures show that China’s public sector revenues and expenditures have been around 20–25 % of GDP in recent years, with deficits around 2–3 % of GDP. The IMF notes that when off-budget liabilities of local governments are included, revenues are slightly larger than official estimates and spending considerably higher. The IMF calculates the public sector deficit has been running at around 10 % of GDP in recent years and that China’s public sector debt as of end-2015 was close to 60 % of GDP. The IMF expects the public sector debt ratio to grow further in coming years.