Public Finance and Management ISSN 1523-9721 Volume 15, Number 4, pp. 358-377 2015 LOCAL GOVERNMENT DEBT IN CHINA: IMPLICA- TIONS FOR REFORM Bhajan Grewal, 1 Enjiang Cheng 2 and Bruce Rasmussen 3 Victoria Institute of Strategic Economic Studies Victoria University, PO Box 14428, Melbourne VIC 8001, Australia ABSTRACT Since the 1994 fiscal reforms, China’s national public finances have been in a strong po- sition, but public finances of local governments (including provincial, city and county gov- ernments) have been always under stress. This is because local governments in China are responsible for financing the provision of basic economic and social services, as well as for urban infrastructure, but they have limited access to tax revenues, have no power to introduce new taxes or to increase rates of existing taxes, and are prohibited under the 1994 Budget Law from borrowing. Consequently, local governments are heavily dependent on non-tax rev- enues and fiscal transfers from the central government. In spite of the prohibition on borrow- ing, most local governments have been borrowing informally for many years and the central government has ignored this breach of the Budget Law. Now the size of local government bor- rowing has reached levels that are causing concerns for the sustainability of local public fi- nances and the stability of the Chinese banking system. This situation raises many policy is- sues, some requiring urgent policy interventions and other requiring medium-term policy re- sponses. Thus, there is a need for broadening provincial powers over taxation, reforming in- tergovernmental fiscal transfers, and formally recognizing provincial borrowing powers. However, the focus of this paper is on the incidence of local debt on provincial and sub- provincial public finances, an aspect of local debt that has not attracted sufficient attention in the literature. The concentration of local debt and contingent liabilities at sub-provincial lev- els and the new annual limit imposed by the State Council on local debt in 2015 are discussed. Lessons learned from Australia’s experience in relation to the management of subnational borrowing are also discussed, as these appear to be highly relevant to China’s current situa- tion. 1. Professorial Fellow, Victoria Institute of Strategic Economic Studies, Victoria University, Melbourne; formerly, Director of Intergovernmental Fiscal Relations, Government of Victo- ria. 2. Associate Professor, Victoria Institute of Strategic Economic Studies, Victoria University, Melbourne.; formerly, Senior China Economist at Citibank, based in Beijing. 3. Director, Victoria Institute of Strategic Economic Studies, Victoria University, Melbourne; formerly, Assistant Director General (Finance), Government of Victoria. The authors are grateful to Wen Zhong for valuable assistance in accessing data from provin- cial audit reports. Paper prepared for the Public Finance and Management Symposium on the Reform of the Fiscal System of the People’s Republic of China.