IMF Working papers: Local Government Financing Platforms in China: A Fortune or Misfortune Part I

1.Local government financing platforms (LGFPs) are the backbone of local
governments in promoting infrastructure development in China. As the principal
financing agents for local governments, their crucial role in upgrading China’s infrastructure
and promoting economic growth has been widely acknowledged. By not encouraging higher
local fiscal deficits or imposing more pressure on local government to issue bonds, LGFPs
could, to some extent, be seen as a fortune for Chinese local governments, as they act as a
vehicle to provide off-balance sheet quasi-fiscal support for local governments.

2. The rapid credit expansion in 2009–10 brought LGFPs into the spotlight. To 

shield the domestic economy from the financial crisis, at the end of 2008 the Chinese 

authorities started to implement fiscal stimulus measures and ease monetary policy. The 

stimulus measures provided a strong impetus for local governments to spend on 

infrastructure to generate growth and create employment. Given their limited revenue base 

and prohibition from direct borrowing from financial markets by the Budget Law, local 

governments relied increasingly on LGFPs to channel funding for infrastructure spending. 

The rapid expansion of LGFPs may turn the fortune to a misfortune as the resulting rapid 

credit expansion to LGFPs triggered concerns regarding local governments’ indebtedness, 

banks’ asset quality, and, more broadly, medium-term financial stability and sovereign risk in 

China, if the causes of rapid expansion are not addressed. 

3. This paper explores the function of LGFPs and the reasons behind their recent 

expansion (Sections II and III). We argue that the relationship between LGFPs and local 

governments is intertwined, and LGFPs’ rapid growth results from an economy that relies 

heavily on investment; a large government role in the economy; revenue and expenditure 

mismatches (at the local government level) exacerbated by the fiscal stimulus; and banks’ 

weak risk management and internal controls. 

4. The rapid development of LGFPs has made the economy subject to the volatility 

of the real estate market and further distorted the economic structure (Section IV). At 

end 2010, the debt by LGFPs amounted to RMB 4.97 trillion, equivalent to two thirds of the 

sum of total local government revenue and transfers from the central government. Moreover, 

since the receipts from the sale of land lease rights are the main sources for debt repayment, a 

correction in real estate prices could hurt the debt servicing ability of local governments and 

LGFPs, and impair banks’ asset quality. In the worst case scenario, it may trigger contagion 

between the financial sector and the sovereign. 

5. The proliferation of LGFP debts and their consequences make it essential to 

understand the causes of their rapid development, address the risks, and more 

importantly, implement measures to prevent a similar phenomenon from recurrence 

(Section V). Given that discussion of China’s economic growth model and monetary and 

financial framework is beyond the scope of this paper, the suggestions raised in the paper 4 

 

cover four areas. First, the mismatches between revenue and expenditure at the local 

government level should be fully acknowledged and addressed. Second, there is a need to 

establish a comprehensive framework to regulate and supervise local government budget and 

financing. Third, it is important to ensure that the financial resources obtained from the sale 

of land are sustainable given the constrained land supply in the medium term, which requires 

a comprehensive strategy for land capitalization. Finally, encouraging the issuance of local 

government bonds and developing them into safe assets can also help to make the land 

capitalization process sustainable and thus alleviate sovereign risk by cutting the 

transmission of contingent risk from local governments to the central government.

 

Prepared by Yinqiu Lu and Tao Sun