Chinese cities are running out of cash on high cost of Covid lockdowns

This week’s protests across China show just how unpopular Beijing’s Covid-zero policy has become. Now, even as the country signals it may loosen pandemic controls, it faces another challenge: Local governments tasked with carrying out mass testing and enforcing quarantine are running out of cash and may be forced to cut costs or cut back on other vital services.

The Covid-zero policy kept China out of recession in 2020. But nearly three years later, the bills are mounting, putting extraordinary financial strain on city officials in the world’s most populous country.

If lockdowns and mass testing persist, “risks to financial stability will increase,” George Magnus, associate at the China Center at the University of Oxford, told CNN Business.

“Local governments are under enormous pressure from the cost of keeping Covid-zero, and we can already see this in the debt sustainability of various entities and [em] instances where public services are being reduced, local assets or services sold, and so on.”

Local governments, whose revenues depend heavily on land sales, are more vulnerable than the central government. They spent 11.8 trillion yuan ($1.65 trillion) more than they took in in revenue between January and October, borrowing heavily to do so, according to data from China’s Ministry of Finance.

Soaring government debt poses a direct threat to China’s economic health. Not only does this increase the risk that municipalities will default on their debts, it also reduces the government’s ability to stimulate growth, stabilize employment and expand public services.

“The Greatest in History”

For nearly three years, local governments have borne the brunt of enforcing pandemic controls. They had to pay for regular mass testing, mandatory quarantine stays and other services during frequent lockdowns, resulting in rising spending even as revenue stagnated.

But they face revenue shortfalls relative to their spending needs. They account for half of general government revenue but account for more than 85% of that expenditure, according to analysts.

DBRS Morningstar, a Toronto-based global credit rating agency, said earlier this month that high local government deficits were a key concern, including so-called “hidden debt” from special financing tools designed to boost funding. for regional governments first.

Part of this debt is never officially recognized on government balance sheets.

“Higher deficits and lower nominal GDP growth are expected to result in China’s general government debt rising to 50.6% of GDP in 2022,” significantly higher than the 38.1% in the pre-pandemic year of 2019, they said.

That would still be relatively low by global standards. But it would represent a record for China.

The weak fiscal position of local governments has been a drag on the country’s overall financial situation.

China’s wide fiscal deficit, which combines central and local government deficits, reached 6.66 trillion yuan ($944 billion) in the first 10 months of 2022, nearly tripling from the previous year, according to calculations by CNN Business. based on data from the Ministry of Finance.

Zhao Wei, chief economist at Shanghai-based Sinolink Securities, estimates that the wide fiscal deficit could exceed 10 trillion yuan ($1.4 trillion) in 2022, the largest in history.

Low income, high costs

Why are local governments in this dangerous state? In previous years, its expenditures had been financed by land sales, which normally accounted for more than 40% of its total income.

But a housing market slump cut off that funding. In the first ten months of 2022, land sales are down 26% year-on-year and are on track for their first decline in seven years due to a slump in demand from developers reeling from a collapse in home sales.

Local government finances are also being strained by a sharp contraction in revenue, as weak economic growth and huge tax breaks for businesses reduce revenue.

More than 3.7 trillion yuan ($524 billion) in tax breaks have been awarded this year to companies hit hard by the pandemic. Meanwhile, China’s economy grew by just 3% in the first three quarters of this year.

At the same time, the costs associated with Covid testing are enormous. Covid-related healthcare spending surged 13% to reach 1.75 trillion yuan (245 billion U.S. dollars) in the first 10 months of 2022, the biggest increase among all types of government spending, official data showed.

From the start of the pandemic to April 2022, 11.5 billion tests were performed in China, according to the government. But the real number could be much higher.

Analysts at Soochow Securities estimate that 10.8 billion tests were performed from April to June alone, suggesting a large increase in the amount of testing.

They believe the cost of Covid testing could reach $240 billion a year if half a billion people in China’s large and medium-sized cities are tested every two days. In May, Beijing told local governments that they should shoulder the costs of regular Covid testing in their regions.

Without pay

Cash-strapped, many cities across the country, including Sichuan and Gansu provinces, have asked residents to pay for tests, although proof of a negative Covid test is still required to enter public places or transport.

“China is sinking deeper and deeper into a quagmire of ‘who’s going to pay?’” Magnus said. “Somehow the local government sector will have to cope, maybe badly, but unless Beijing makes the money available, that’s how it goes.”

A lack of cash has already led some local authorities to delay or suspend payments to Covid testing providers.

In the first nine months of this year, 15 of the largest listed virus testing providers in China reported a combined total of 44 billion yuan ($6.15 billion) in accounts receivable or accounts payable, a 71% increase on year-on-year, according to data compiled by a unit of China Finance Online, a provider of financial information services.

Some labs even suspended services. Earlier this month, a Covid testing laboratory in the central province of Henan said it needed to stop testing because local authorities had not paid any bills since January 2021.

End of Covid-zero policy?

Despite rising infection rates, there are signs that some cities are easing Covid restrictions after a series of nationwide protests last week.

The southern city of Guangzhou announced on Wednesday that it would lift lockdown measures in key districts after people clashed with police demonstrations against overly restrictive restrictions. The southwestern city of Chongqing also eased Covid restrictions on the same day.

Deputy Prime Minister Sun Chunlan, who is in charge of public health affairs, said on Wednesday that China was at “a new stage” in the fight against Covid-19.

The country may still be a long way from completely ending its Covid-zero policy. Vaccination rates among the elderly and hospital capacity need to improve, according to Sun.

While the huge costs associated with the Covid-zero policy are not financially sustainable, the policy is likely to continue as long as protests remain isolated and sporadic, said Craig Singleton, senior fellow at the Foundation for Defense of Democracies, a Washington-based think tank. , adding that local authorities can still rely on Covid restrictions to limit any rise in cases.

Local governments are under pressure to prevent outbreaks. Officials who failed were penalized, creating the potential for a disconnect between a change in central government tone and reality in cities.

“Politics is paramount,” said Andy Xie, an independent economist. “Local governments must find money for Covid-zero. They can cut spending elsewhere. Otherwise, they will be fired.”