SinoInsight 1
China’s economy continues to underperform. Second quarter GDP growth clocked in at just 7.9 percent year-on-year, (up 1.3 percent quarter-to-quarter) lower than forecasts of over 8 percent. Also, the People’s Bank of China freed up 1 trillion yuan in a surprise reserve requirement ratio (RRR) cut effective on July 15, signaling more weakness in the Chinese economy.
Signs that the PRC government is seeing serious fiscal shortages have also been emerging:
1. Since the beginning of June, the central government has been requesting that local governments “clear up” civil servant bonuses and subsidies issued in violation of regulation. In particular, the CCP General Office issued a notice to local governments urging them to take additional and stricter measures to “clear up illegal local government civil servant pay and subsidies” (“中共中央辦公廳國務院辦公廳關於進一步嚴肅紀律清理規範地方違規發放公務員工資津貼補貼的通知”). Minutes of meetings on central government instruction, some of which were once put up on local government websites, have since been taken down.
In early July, local governments started forcing civil servants to unconditionally return all bonuses and subsidies issued in June. Many civil servants took to social media to vent their frustration with the situation.
From various social media posts, it appears that civil servants from Chaozhou City in Guangdong Province had received notices of bonus and subsidy suspension as early as July 3. Three days later, Shanwei City in Guangdong also began suspending bonuses and subsidies for civil servants. Meanwhile, some work units in Shenzhen have been tabulating employee income in recent years.
Over in Shanghai, the municipal government has apparently stopped issuing bonuses for the first quarter of 2021, according to social media posts.
On July 7, the Nanchang Water Conservancy Bureau in Jiangxi Province issued a “red-letter head” notice (a higher priority government document; regular priority documents are printed in black ink) on withdrawing government incentives for civil servants (“關於清退政府性獎勵的通知”). According to the document, all work units must recover all government incentives (bonuses and subsidies) issued after June 7, 2021 within 10 days of the notice or be dealt with under relevant regulations.
In Dexing City in Jiangxi Province, the local government requested that teachers return so-called “high-quality bonuses” (高質量獎金) back to the authorities. According to social media posts, performance bonuses for teachers in the first quarter of 2021 was 20,000 yuan (about $3,092). This meant that teachers in Dexing City could miss out on at least 80,000 yuan in bonuses this year (not including year-end bonuses). Civil servants can make more in bonuses in a year than their regular salary.
2. Recent developments concerning government bonds also hint at trouble for the PRC’s finances.
On July 6, mainland media reported that the scale of local government bond issuance in the first half of 2021 was 3.34 trillion yuan, a 4 percent decrease from the same period last year. Of the 3.34 trillion yuan of bonds, 1.51 trillion yuan were newly issued bonds and 1.83 trillion yuan were refinancing bonds. The 1.83 trillion yuan of local government refinancing bonds issued in the first half of 2021 represents a year-on-year increase of 161 percent.
The local government bonds issued in H1 2021 represent 35.4 percent of the 4.2676 trillion yuan limit that the PRC finance ministry set for 2021. Unless the central government changes its arrangements, local governments are set to issue nearly 2.8 trillion yuan worth of bonds in the second half of the year.
On July 1, the central government introduced measures to monitor the progress and performance of local government special bond projects (“地方政府專項債券項目資金績效管理辦法”). The measures state that financial departments, bond project management departments, and project work units as well as individuals at all levels of local government will be held accountable (including with the threat of criminal punishment) should their respective projects seriously underperform or generate severe losses.
3. On July 11, Chinese netizens circulated a China Banking and Insurance Regulatory Commission (CBIRC) guidelines on resolving local government implicit debt risks (“銀行保險機構進一步做好地方政府隱性債務風險防範化解工作的指導意見”). The guideline was classified as not-for-public, and bore the serial number “CBIRC Issue [2021] No. 15” (銀保監發[2021]15號). Mainland news portals reported on the guidelines, but subsequently scrapped those articles.
The guidelines required all banking and insurance institutions to strictly implement local government financing policy requirements; “dispel illusions” that the central government would step in to bail out struggling institutions; strengthen compliance management; do due diligence; strictly forbid banking and insurance institutions from adding to or falsely resolving local government implicit debt; and warned that those institutions will be severely punished if they help local government add to or falsify resolving their implicit debt.
The content of the guidelines (they are in line with the CCP’s de-risking agenda) and mainland news portals’ self-censorship suggest that the document is authentic. The CCP likely classified the document and censored reports about it to maintain its “all’s well” (形勢一片大好) propaganda facade and avoid alarming the Chinese people about the government’s debt problems.
OUR TAKE
1. Beijing has been instructing local governments to implement “belt tightening” policies to “pass tight times” (“過緊日子”) for a while, most prominently during premier Li Keqiang’s government work report speech at the 2020 Two Sessions.
However, it is clear from the central government’s recent effort to micro-manage the sort of “belt tightening” policies that local governments are supposed to be implementing that the Xi leadership still struggles to have the rest of the regime comply with Zhongnanhai’s orders (政令不出中南海). Further, the CCP’s cutting back on civil servant bonuses and subsidies indicates that the regime’s fiscal shortages are not trivial. While the central government is careful to state that only “illegal” bonuses and subsidies should be withdrawn, local governments will likely “prefer left rather than right” (寧左勿右) and find reasons to avoid paying its civil servants anything beyond their standard salary.
Cutting civil servants off their bonuses and subsidies may help the CCP government reduce financial expenditure and save some money in the short run. The move, however, will cause headaches for the regime over time. For one, civil servants ensure that the regime is functional and are an important constituent of the Party, and the CCP risks alienating civil servants by taking away their valuable supplementary pay. For civil servants already living in tight financial conditions, being cut off from bonuses and subsidies will come as a personal crisis. Such civil servants will be compelled by circumstances to “recoup” their remuneration losses through corruption, or find other ways to damage the CCP’s interests.
Then there is the problem of weakening the Chinese people’s ability to consume. The CCP needs people spending money to boost China’s economic recovery, but civil servants with less disposable income will naturally consume less. The CCP’s “1.4 billion people mass market” propaganda amounts to little if consumption is on the low side, the CCP regime will struggle to roll out its “dual circulation” model.
The CCP is caught in a “Catch-22,” and is damned no matter which option it takes. Fiscal shortages will likely worsen if “unnecessary” spending is not cut, but “belt tightening” measures will disrupt the economy and heighten political risks for the regime.
2. The central government, in strengthening efforts to manage and punish local governments over underperforming special bond projects, will inevitably make local governments more hesitant to make investments and take risks. As things currently stand, local governments are already under immense pressure to turn things around financially—China’s worsening economy impacts the provinces; various industries are struggling to make a profit amid the COVID-19 pandemic and other factors; China’s technology sector is subjected to international sanctions; and “new infrastructure” projects announced last year are not taking off very well. The fact that local governments have only issued just over a third of bonds per the quota for 2021 in the first half of 2021 suggests that they are struggling to find suitable projects to invest in.
In general, local governments from richer provinces will find it easier to meet central government requirements. Last November, the PRC finance ministry issued a document on promoting local government bond issuance and “marketization” (“關於進一步做好地方政府債券發行工作的意見”). In early June, the Guangdong local government clinched the lead in market-based pricing, breaking the long-standing 25 basis points lower limit interest difference between local and central government bonds (the interest rate on Guangdong’s bonds was just 15 basis points higher than central government bonds). Subsequently, the wealthy eastern Chinese provinces of Zhejiang and Jiangsu also issued local government bonds with comparable rates to Guangdong. In contrast, the Heilongjiang local government issued a 12.3 billion yuan bond to local small- and medium-sized banks with an interest rate that was 45 basis points higher than that of central government bonds. Going forward, the discrepancies between richer and poorer provinces will grow wider, with poorer provinces struggling to issue government bonds and richer provinces being more solvent (low interest rates —> low financing costs —> lower risks —> easier and greater scale of bond issuance).
Meanwhile, small- and medium-sized banks that have been helping poorer local governments sell their bonds will also face financial risks. As things stand, those banks are reliant on local government financial “blood transfusions” and mergers to stay afloat, but poorer local governments will struggle to find business for the banks because their debt is not attractive to investors. While large state-owned banks can technically sell poorer local government bonds, investors will find those bonds unattractive and the large banks will not be interested in carrying them.
SinoInsight 2
On June 28, state mouthpiece Xinhua reported that the CCP had issued a new Xi Jinping book on “strictly governing the Party” (“習近平關於全面從嚴治黨論述摘編 [2021年版].” The book contained excerpts from Xi’s speeches, instructions, reports, and internal speeches, some of which were made public for the first time, from Nov. 15, 2012 to April 27, 2021.
Among the newly available content was an excerpt from an internal meeting of the Central Commission for Discipline Inspection in January 2021 where Xi criticized officials for lacking initiative. “Some [officials] only get moving when they receive written edicts issued by the leadership and they would do nothing without such instructions,” Xi said. “My written instructions are the last line of defense. If I didn’t hand out instructions, would these officials do any work?”
OUR TAKE
1. Xi Jinping’s frustration with officials waiting on orders from the top instead of taking initiative affirms what we have been repeatedly saying:
- Beijing’s orders are not being carried out properly, or in Chinese parlance, “not making it past the gates of Zhongnanhai” (政令不出中南海).
- PRC officials are afraid of being “politically incorrect” and punished as Beijing tightens control over the regime (cong yan zhi dang, 從嚴治黨), and hence prefer inactivity or “playing it safe” to minimize personal political risks.
- Officials opposed to Xi are carrying out “passive resistance” to his rule through inaction and procrastination (bu zuo wei, 不作爲).
- Officials who are not factional struggle participants but who are aware of infighting in the CCP elite believe it is a safer bet to sit on their hands and wait for the balance of the struggle to become clearer before throwing in their lot with the likely winner.
To overcome bureaucratic inertia, Xi has:
- Attempted to sway the balance of factional struggle decisively in his favor by launching an anti-corruption campaign to purge factional rivals and keep the rank-and-file honest; consolidating power to a very high degree; doing way with presidential term limits to clarify his staying power and avoid being a “lame duck” leader; and “borrowing” tokens of “quan wei” from past leaders (“core leader” — Deng Xiaoping; “people’s leader” — Mao Zedong).
- Repeatedly emphasized the need to “strictly govern the Party” (cong yan zhi dang).
- Issued a Party regulation in February 2019 (中國共產黨重大事項請示報告條例) clarifying when subordinates should request instructions or approvals from their superiors on major issues.
- Strengthened supervision of leading officials, including holding them accountable for the actions of their subordinates.
2. Xi’s problems with officials lacking initiative, however, is a feature, and not a bug, of totalitarian communist regimes in general. So-called “liberal” CCP leaders like Deng Xiaoping, Jiang Zemin, and Hu Jintao have been praised by Western observers for allowing officials more freedom to operate, but many officials used their “initiative” to engage in regime-undermining corruption. Also, while Xi has been faulted for causing China’s economic downturn by stifling the “innovation and initiative” of PRC officials, the Chinese economy’s deterioration had already begun in Hu Jintao’s second term as years of corruption and malpractice took its toll. Put another way, official initiative will always be a problem in China as long as the Party is in charge.
PRC officials will attempt to reconcile the contradictions of Xi’s instructions and the CCP’s techno-totalitarian rule in the safest way, that is, “prefer left rather than right.” For example, the CCP’s “wolf warrior” diplomats and propagandists will focus on Xi’s recent call to project “confidence” instead of being “lovable” in implementing “China’s international communication capabilities.” Also, subordinate officials will rather wait for written instructions from Xi or their superior officials than take the “wrong” initiative and be held accountable later.
In short, Xi’s latest effort to promote initiative in the officialdom will almost certainly amount to nothing. Officials will meet Xi’s call with plenty of sloganing and flattery, but will still not dare to break bureaucratic inertia. Ultimately, PRC officials will do whatever it takes to preserve their self-interests, while saddling Xi and the CCP regime with all the risk of inaction and procrastination.
