3. Lastly, it cannot be assumed that all debts will turn bad. Many of the LGVFs are commercially orientated and several projects are either in part or entirely backed by cashflows or have other assets as collateral.

The current attention on local government debt stems fundamentally from two issues.

1. The current tax revenue split between local governments (LG) and the central government (CG) is not in line with current spending needs. This is a medium-term issue that the new government needs to and most likely will resolve.

2. A very tight monetary policy environment has hampered LGs’ efforts to raise revenues. However this tightening cycle is nearing its peak, especially with the most recent interest rate hike on July 7 further tightening is unlikely.

To elaborate on the points above, the central government receives around 70 per cent of total tax revenue, which is increasing at a pace of over 30 per cent annualised. The spending of the central government is generally limited to welfare spending, including medical care and pensions.

In contrast, local governments receive around 30 per cent of tax revenue, but have much higher spending needs. In fact, LGs pay for all government infrastructure spending, including the massive spending outlays related to the stimulus package of 2009, and more importantly, the LGs will pay for a large chunk of the social housing plans announced recently (10 million units of social housing will be built each year in 2011 and 2012, with 50 million completed within five years).

The main revenue for some LGs has been profits from land sales, but this has fallen by 50 per cent year-on-year due to property restrictions and the current tight fiscal and monetary environment. LGs have generally been in a distressed situation given the revenue-spending mismatch.

Further tightening measures on the property sector will be limited given the severity of current measures and if property prices start falling, there might be some selected relaxation of these measures. The property market is currently stagnant and transaction volume has dried up, instead of the government’s hoped for fall in prices, but not sales.

If there is a selected relaxation in property measures, we could see a rebound in property sales and therefore some spillover to the land market, which could be another source of revenue for LGs.

To make matters worse LGs cannot issue bonds, as Beijing keeps strict control over major revenue-raising activities.