Media Center

printer friendly version

International Conference on Sub-national Government Debt Management

Opening Remarks by
Klaus Gerhaeusser
Director General, East Asia Department
Asian Development Bank

10 July 2008
Hangzhou, People's Republic of China

Good morning ladies and gentlemen.

Mr. Xu Hongcai, Deputy Director General, Budget Department, Ministry of Finance (MOF)
Mr. Luo Shilin, Deputy Director General, Zhejiang Provincial Finance Department

Distinguished participants.

I am honored to represent the Asian Development Bank (ADB) today at this International Conference. It is indeed a privilege for the ADB to be associated with this important and timely initiative. Discussion of international practices for managing sub-national government debt will help impart the best international knowledge to the People's Republic of China, and facilitate strengthening the capabilities of the newly created Local Governments' Indebtedness Management Division of the MOF.

I also take this opportunity to thank the Governments of Germany, India, Japan, the United Kingdom, and the United States of America for sending experienced and senior experts in debt management to share knowledge in response to a request of the Government of the People's Republic of China (the Government).

This conference demonstrates that the Government is concerned with the growing explicit, implicit, and contingent liabilities of the provincial and local governments, whose borrowings have been increasing rapidly in recent years. The Budget Law in the PRC prohibits the provincial and local governments from directly borrowing from the market, but allows indirect borrowing from the Central Government and external aid agencies as on-lending from the Central Government. Yet, in practice, provincial and local governments have been borrowing using various vehicles, including state-owned enterprises, and other state agencies and institutions, such as hospitals and educational institutions, often with guarantees-explicit or implicit. Measuring sub-national government implicit liabilities is a challenge due to the complexity and non-transparent nature of the transactions. The institutional framework to capture and regulate sub-national government's liabilities is yet to be fully established. Consequently, much of these borrowings are not captured in the budget and their true magnitude is thus not known.

The PRC has a more decentralized public finance system than many developed and middle income countries. Sub-national governments incur about three quarters of all public spending and employ some 95% of all public employees. Yet, they raise less than half of total public revenues. Faced with insufficient resources, substantial expenditure responsibilities, and a ban on borrowing, local governments resort to borrowing from or through their enterprises, and often run arrears in payments to suppliers and services providers. Thus, the genesis for substantial increase in sub-national governments' implicit borrowings could be found in this structural imbalance between expenditure responsibilities and revenue sources and the system of fiscal transfers. The 1994 reforms in tax sharing introduced stability and clarity in tax assignments between the Central and sub-national governments. But the reforms also seem to have contributed to widening this vertical imbalance by assigning more revenues to the Centre while increasing sub-national governments' spending responsibilities.

However, it should be noted that such vertical imbalances are not uncommon, and are generally in-built into federal systems the World over, mainly for two reasons: (i) taxes are more efficiently and effectively collected in a centralized manner; and (ii) expenditures, particularly on social services, are efficiently and equitably made in a decentralized manner. Therefore, what one sees in the form of vertical imbalance in the PRC is not a problem per se-it is a common feature in any large country with several layers of governments. The main issue, however, is how that imbalance is managed.

Many countries with several layers of government deal with this imbalance effectively through an arbitration process that ensures a transparent, rule-based system of fiscal transfers to promote fiscal efficiency and equity. Usually, the institution responsible for division of resources between the Central and sub-national governments are given a considerable degree of independence to make recommendations, keeping in mind the interests of both the Central and the sub-national governments.

Although the PRC is not a federation in the formal sense of the term, it has all the features of a large federal country-it is large and diverse, has several layers of government, and has a formal system of division of responsibilities. Therefore, the fiscal transfer system in the PRC also needs to have at least some key features of similar arrangements in other large countries with several layers of government. An institutional arrangement based on rules that balances the needs of sub-national governments with the resources available at the Central Government level, in a manner that promotes efficiency in the use of fiscal resources and reduces regional fiscal imbalances, is needed to effectively address this structural imbalance.

A major problem with the growing implicit and explicit liabilities of sub-national governments is the risk those borrowings impart to the financial sector, as most of these borrowings tend to be from the banking sector. Therefore, in addition to addressing the structural and institutional problems of vertical fiscal imbalances between different layers of government, reforms in this area will need to address a number of other related issues such as: (i) strengthening the regulation of the financial sector to tighten appraisal of lending to state-owned enterprises and local governments; (ii) introducing a system of independent credit rating for state-owned enterprises and sub-national governments; (iii) reforming financial management, control, and reporting to account for implicit liabilities of sub-national governments and state-owned enterprises; (iv) strengthening the monitoring, management, and regulation of sub-national government liabilities by the Central Government; and (v) improving corporate governance in state- owned enterprises including their management and control by sub-national governments.

Realizing the risks associated with such unregulated borrowings both to the fiscal system and the financial sector, the Central Government set up a task force in the Ministry of Finance in 2005, to make recommendations for managing the debt of provincial and local governments. The responsibilities of this task force have since been transferred to the newly created Local Governments' Indebtedness Management Division in the MOF. The Government has sought ADB technical assistance to support the work of the new Division for estimating the magnitude of local government debt, and preparing a blueprint for an early warning and risk-rating and monitoring system. Knowledge of the sources and magnitude of implicit liabilities of sub-national governments and the use of a risk-rating and early warning system will help the Government to set specific targets and norms for managing the level of implicit and explicit debt of sub-national governments. The technical assistance, which is expected to be approved shortly, will also study the feasibility of issuance of securities in the market by sub-national governments.

Reforming the management of sub-national government liabilities is a complex process. The presentations on country experiences at this International Conference will indicate how this complex process is being managed in different countries. ADB considers it a privilege to be a part of this effort to exchange international experience in an area of immediate relevance to policy makers in the PRC. We also appreciate that the conference will lay a good foundation for implementing ADB's forthcoming technical assistance for strengthening sub-national government debt management.

In closing, I would like to thank the Government of the People's Republic of China for inviting the ADB to participate in this conference, and the international resource persons for their participation in the conference to share their experiences.

Thank you for your attention.