Local government financing vehicle

After the economic reforms of the late 1970s, China's economic growth was largely fueled by rural areas. The result of this growth was that in 1993, only 22% of Chinese tax revenue was being collected by the national government.

In 1994, China underwent financial reforms with a goal of "fiscal recentralization", which aimed to boost the national government's earnings. In doing so, they shrank local tax revenue to below 50% of the total, down from 78%. Local governments still shouldered 70% of regular spending.[7] The reforms also mandated that local governments must have balanced budgets and zero debt, which made it much harder for them to secure financing for infrastructure development.[8]

The 1994 reforms, however, permitted local governments to engage in land financing, where they would earn revenue through leasing land. In addition, the reforms saw the central government give up its share of land transfer proceeds, so the proceeds would belong entirely to local governments.[7] This incentivized local governments to increase land value by developing infrastructure, and LGFVs emerged as a solution to the problem of raising finance for these projects.

The 2007–2008 financial crisis prompted the Chinese government to introduced a 4 trillion yuan ($562 billion) national stimulus plan.[9] 72% of the stimulus plan consisted of infrastructure funding, and the central government funded only 30% of the package.[10] This rapidly increased the rate of borrowing by local governments through LGFVs, with around two thirds of the package funded through borrowing.

In 2014, Chinese local governments were permitted to borrow money directly, in an attempt to reduce their reliance on LGFVs. By 2017, bonds represented 90% of local government debt, up from 7% in 2014 (when most debt was borrowing from banks).[11]

In 2015, the Chinese government introduced a Free Trade Zone in Nansha District, which trialed a new model of land finance to encourage private investment in development.

In 2018, the central government announced that it would not bail out LGFVs that go bankrupt, in order to signal the need for caution to the financial markets.[8]

Around this time reforms were made which increased local government's share of value-added tax from 25% to 50%, and granted them a share of the consumption tax.

It was estimated that revenue from the sale of land use rights (LUR) constituted 60-80% of local government revenue in 2018.[12] In 2019, LGFV bonds constituted 39% of total outstanding corporate bonds in China's domestic (onshore) bond market, with widely varying credit risks.[13]

The 2020 Chinese property sector crisis heightened concerns about local governments' reliance on LGFVs and land sales, with local government bonds reaching 28.6 trillion yuan (US$4.5 trillion), or 23% of the entire Chinese bond market.[14] The International Monetary Fund estimated that local government debts nearly doubled from 2018-2023, reaching 66 trillion yuan ($9 trillion), nearly half of China's annual economic output.[9]

Although no LGFV has ever defaulted as of 2023, some have been making last-minute payments,[15] which can indicate financial distress.

In October 2021, the Wall Street Journal reported that the central government was planning to implement a nationwide property tax, to tackle real estate speculation and provide local governments with more stable revenue. However, the report detailed widespread resistance within the Chinese Communist Party, leading to various alternative proposals including state-owned housing. On 23 October, a five-year trial of the proposed tax was announced for select regions with particularly hot property markets, such as Shenzhen, Hangzhou and Hainan.

Although the property tax could reduce government reliance on land value through LGFVs, it has been estimated that a property could reduce land value by 50%, and that this risk to property owners was contributing to lower land sales.[16] In April 2023, the government completed a unified real estate registration system, which could enable the property tax to be implemented.[17]

In July 2023 China's state-owned banks began providing loans to LGFVs with a generous repayment period of 25 years, in an attempt to relieve some of the pressure.[18]