Author Archives: Deborah Lucas

China’s Growing Local Government Debt Burden

1.27.16 Chinas Growing Local Government Debt BurdenHigh rates of debt growth by local governments are a cause for concern in any country. In China, where recent turmoil in the equity and foreign-exchange markets has put a spotlight on that country’s economy and growth prospects, increasing levels of borrowing by provincial and other lower levels of government has resulted in local indebtedness rising nearly fourfold since 2008, reaching about 40 percent of GDP.

Debt growth of that magnitude raises concerns about fiscal sustainability, debt affordability, transparency and accountability. Cautionary tales abound. From New York City in the ‘70s, emerging market countries in the ‘80s, Russia in the ‘90s, and Detroit, Greece and Puerto Rico more recently, there is a long list of governments that have experienced the painful economic repercussions of taking on debt they could not afford.

A new policy brief from the MIT Center for Finance and Policy by Xun Wu, a visiting scholar at the Center, suggests that while the massive debt buildup in China presents challenges, the situation is not as dire as a full-blown debt crisis. In fact, Chinese policymakers appear to be taking steps to mitigate the risks, including shutting down some of the more opaque financing channels and operations that facilitated the explosion of local debt in recent years.

Moreover, the central government of China is taking measures to restructure local debt—pointing to the possibility, and perhaps likelihood, of a larger bailout should debt levels become unmanageable. While further measures may be necessary, local debt levels also may stabilize if the pace of public infrastructure investment slows as China’s voracious appetite for public works is finally satiated.

However, a structural imbalance between local government spending and access to tax revenues remains a fundamental tension that has yet to be addressed. The central government ultimately has political and financial control over the entire public sector, and policies and regulations emanating from Beijing dominate borrowing and budgetary decisions. Currently local governments receive about 50 percent of taxes collected but are responsible for about 80 percent of expenditures. The resulting gap continues to be filled from other sources, primarily through borrowing and land sales.

As for differential impacts across the country, China’s more affluent eastern provinces have the greatest levels of debt in absolute terms, but as a share of local GDP their burden is manageable compared with the poorer western provinces.

China’s situation is complex as the country attempts to turn its government-dominated economic growth model into a market-oriented one. From that perspective, how it manages its local fiscal imbalances will be telling about the commitment to and speed of those larger changes.

The policy brief, which can be found here, is the first in a series of CFP Policy Briefs that will highlight innovative research conducted on issues residing at the intersection of finance and policy. The aim is to provide accessible, objective, quantitative, and non-partisan analyses that further public policy discourse and help inform decision-making in the public and private sectors.

Who pays when Greece defaults on the IMF?

Greece recently failed to pay $1.7 billion due to the IMF, thereby becoming the first developed country to default on an IMF loan. That missed payment represents only a portion of the approximately $23 billion in IMF credit outstanding to Greece, suggesting the ultimate losses to the Fund could be much bigger.

The good news is that the potential losses are small in comparison to the IMF’s $350 billion in pledged resources from its members. Barring massive contagion, there is no threat from Greece to the Fund’s solvency.

Nevertheless, the costs to the IMF are likely to be significant. And ultimately it is the taxpayers from the IMF’s 188 member countries that will bear them. The losses are distributed unevenly because membership shares across countries vary widely. The U.S. holds the largest stake, at 17.6 percent of the total. The next largest shares belong to Japan, Germany, France, the UK and China, at 6.6, 6.1, 4.5, 4.5 and 4.0 percent respectively.

The IMF’s opaque financial disclosures and the vagaries of member government accounting practices will allow those taxpayer losses to go largely unnoticed. Member exposures arise through their “quotas,” which are obligations to deposit funds with the IMF. The deposits are backed by the IMF’s substantial holdings of gold, its loans and other assets. The IMF offers a succinct description of its funding structure here.

Some contend that quota payments made to the IMF are investments and not a taxpayer expense. They argue that balances earn interest at the fund and can, at least in theory, be withdrawn if a participating country so chooses. However, when the price of an investment exceeds its value, the investors take an immediate loss. When the IMF offers financing at concessionary terms to distressed countries, it provides subsidies that are paid for by taxpayers. Those subsidies are much smaller than the total amounts paid in, but nevertheless significant.

Of course the benefits of the IMF’s support of the international monetary system and aid to troubled economies may greatly exceed the associated costs to member countries. The point here is that in the interest of transparency, it is worthwhile to quantify the costs (and benefits) more carefully than has typically been done. Work at the CFP has looked at the cost of related guarantees – such as our work to evaluate the cost of government credit support in the OECD context – but we have not yet studied the IMF deeply.

Apart from IMF loans feeling a bit like play money, another factor that may have muted the repercussions in financial markets of Greece’s default to the IMF is that the event didn’t trigger payments on Greek CDS contracts. This is a reminder that CDS contractual terms do not always align with one’s intuitive notion of what constitutes a default, and complicates the relation between CDS pricing and bond valuations.

Professor Deborah Lucas is the Sloan Distinguished Professor of Finance at MIT’s Sloan School of Management, and the Director of the MIT Center for Finance and Policy. Doug Criscitello is the Executive Director of  the MIT Center for Finance and Policy.

For more information, please visit the CFP website

Unfunded State and Local Healthcare Benefits, the Elephant in the Room?

Last week Bob Pozen, a Visiting Senior Lecturer here at MIT Sloan with a distinguished background in government, business and education gave an eye-opening lunch talk. The topic was “Other Post-Employment Benefits” or OPEBs—which is accounting jargon for the liabilities governments incur for retiree healthcare.

Here’s what he found:

“The 30 largest American cities had over $100 BILLION in retiree healthcare deficits in 2013, as estimated by the Pew Charitable Trust. In that year, New York City showed the most serious retiree healthcare deficits at $22,857 per household. The retiree healthcare deficits of the States were even larger in 2013 — a total of $528 BILLION according to the credit rating agency Standard & Poor’s.”

How have such enormous liabilities gone largely under the radar? One reason appears to be lack of transparency in how they are reported. Governments are not required to fund those liabilities, and in most places they don’t appear on balance sheets. (That omission will be corrected if GASB, the government accounting standards setter, prevails.) OPEBs also lack the constitutional protections of pension promises. That means cities like Detroit that run into financial trouble may find a way out of those obligations. In most places though, taxpayers will foot the bill unless benefits are renegotiated.

You can read more about OPEBs and Bob’s suggestions for how to address them at:

Real Clear Markets – “Unfunded Retired Healthcare Benefits are the Elephant in the Room

Boston Globe – “Boston Must Rein Retiree Health Plans