Dominique Strauss-Kahn struck an optimistic note in response to the State Council of China’s 2009 announcement of an unprecedented 4 trillion RMB fiscal-stimulus package, in the wake of global financial recession. Strauss-Kahn, managing director of the International Monetary Fund at the time, said the stimulus would “have an influence not only on the world economy in supporting demand but also a lot of influence on the Chinese economy itself, and I think it is good news for correcting imbalances.”
But less than a decade later, China’s local governments are struggling under massive debt caused by the stimulus, research suggests. Tsinghua University’s Zhuo Chen and Chun Liu along with Chicago Booth’s Zhiguo He document how the stimulus led to rising debt and a surge across China in shadow-banking activities—lending and financial activities conducted by institutions not regulated as banks.
Basing their analysis on various public and nonpublic data sources, Chen, He, and Liu estimate that the stimulus took the form of around 5 trillion RMB in bank loans that were pushed to the Chinese economy in 2009 alone. Meanwhile, the total debt balance of Chinese local governments ballooned from 6 trillion RMB in 2008 to 27 trillion RMB in 2016, with most of that debt coming from nonbank loans.
According to the researchers, this dramatic growth in nonbank, local-government debt is a manifestation of the 2009 stimulus plan’s overhang effect. Local governments took out bank loans in 2009, but they had to repay all those loans around three to five years later, at which point the governments resorted to nonbank financing to either continue their long-term infrastructure projects or roll over their maturing bank loans.
To track shadow-banking activity, Chen, He, and Liu looked at municipal corporate bonds, one form of nonbank financing that many local governments took on. These bonds are issued by local governments and used to finance infrastructure projects whose economic benefits and revenue streams materialize several decades later. The researchers find that the shift toward nonbank debt across China strongly paralleled a tremendous rise in China’s shadow-banking sector. They demonstrate that in provinces where local governments took out more-stimulus-related loans in 2009, there was, from 2012 to 2016, more growth in municipal corporate bonds and shadow-banking activities.
Local-government nonbank debt, as a fraction of China’s shadow-banking balance, grew from a negligible 1.5 percent in 2008 to 22 percent in 2014 and 48 percent in 2016, write Chen, He, and Liu. Local governments especially turned to this type of financing after 2012, when bank debt came due. As many economists believe that Chinese governments will continue to finance their debts through shadow banking, it’s clear that stimulating China’s economy has come with a significant cost.