Document of The World Bank
FOR OFFICIAL USE ONLY
Public Disclosure Authorized Report No. 101493‐CN
INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT
PROGRAM DOCUMENT FOR A PROPOSED LOAN
IN THE AMOUNT OF EQUIVALENT TO US$200 MILLION TO
Public Disclosure Authorized PEOPLE’S REPUBLIC OF CHINA
FOR THE
CHONGQING‐DADUKOU DISTRICT FISCAL SUSTAINABILITY DEVELOPMENT POLICY FINANCING
December 13, 2016
Public Disclosure Authorized
Macroeconomics & Fiscal Management Global Practice Governance Global Practice East Asia and Pacific Region
Public Disclosure Authorized This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.
China‐Government Fiscal Year January 1 – December 31
Currency Equivalents (Exchange rate effective as of December 2015)
Currency Unit = RMB RMB1.00 = US$0.16 US$1.00 = RMB6.40
ABBREVIATIONS AND ACRONYMS
CAS Country Assistance Strategy CCP Chinese Communist Party CFAA Country Financial Accountability Assessment CMFB Chongqing Municipality Finance Bureau CNAO China National Audit Office DOF Department of Finance DPF Development Policy Financing DRC Development and Reform Commission DSA Debt Sustainability Analysis FAI Fixed Asset Investment FYP Five Year Plan GDP Gross Domestic Product GNP Gross National Product GRS Grievance Redress Service HIPC Heavily Indebted Poor Countries IBRD International Bank for Reconstruction and Development ICOR Incremental Capital‐Output Ratio IDA International Development Association IFC International Finance Corporation IMF International Monetary Fund IPO Initial Public Offering JSAN Joint Staff Advisory Note LDP Letter of Development Policy LGFVs Local Government Financing Vehicles MDGs Millennium Development Goals MIS Management Information System MOF Ministry of Finance MTEF Medium‐Term Expenditure Framework MTFF Medium‐Term Fiscal Framework MTFS Medium‐Term Fiscal Strategy NDRC National Development and Reform Commission NPC National People’s Congress NPL Non‐performing Loan
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OECD Organization for Economic Cooperation and Development PBOC People’s Bank of China PBSOE Public Benefit State Owned Enterprise PEFA Public Expenditure and Financial Accountability PER Public Expenditure Review PFM Public Financial Management PPP Public Private Partnership RMB Renminbi (Chinese national currency) SDR Special Drawing Rights SPV Special Purpose Vehicle TSA Treasury Single Account UDICs Urban Development Investment Corporations UNDP United Nations Development Program VAT Value Added Tax WBG World Bank Group
Regional Vice President: Victoria Kwakwa, EAPVP EFI Practice Group Vice President: Jan Walliser, GGEVP Country Director: Bert Hofman, EACCF Senior Practice Director: Carlos Felipe Jaramillo, GMFDR; Deborah Wetzel, GGODR Practice Director: John Panzer, GMFD2; James Brumby, GGOPS Practice Manager: Mathew Verghis, GMF02; Robert Taliercio, GGO14 Task Team Leader: John Litwack, GMF02; Min Zhao, GGO14
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CHINA CHONGQING‐DADUKOU DISTRICT FISCAL SUSTAINABILITY DPF PROGRAM
TABLE OF CONTENTS
SUMMARY OF PROPOSED LOAN AND PROGRAM ...... 6 1. INTRODUCTION AND COUNTRY CONTEXT ...... 7 2. MACROECONOMIC POLICY FRAMEWORK ...... 9 2.1 RECENT ECONOMIC DEVELOPMENTS IN CHINA...... 9 2.2 MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY IN CHINA ...... 12 2.3 THE SUBNATIONAL CONTEXT ...... 13 2.4 INTERGOVERNMENTAL RELATIONS ...... 19 3. THE DADUKOU DISTRICT GOVERNMENT’S PROGRAM ...... 21 4. THE PROPOSED OPERATION ...... 22 4.1 OPERATION DESCRIPTION AND LINK TO GOVERNMENT PROGRAM ...... 22 4.2 PRIOR ACTIONS, RESULTS AND ANALYTICAL UNDERPINNINGS ...... 23 4.3 LINK TO CPS, OTHER BANK OPERATIONS AND THE WBG STRATEGY ...... 29 4.4 CONSULTATIONS, COLLABORATION WITH DEVELOPMENT PARTNERS ...... 30 5. OTHER DESIGN AND APPRAISAL ISSUES ...... 30 5.1 POVERTY AND SOCIAL IMPACT ...... 30 5.2 ENVIRONMENTAL ASPECTS ...... 31 5.3 PFM, DISBURSEMENT, AND AUDITING ...... 32 5.4 MONITORING AND EVALUATION ...... 33 6. SUMMARY OF RISKS AND MITIGATION ...... 34 ANNEXS ANNEX 1: CHONGQING‐DADUKOU DISTRICT FISCAL SUSTAINABILITY DPF ‐ POLICY AND RESULT MATRIX ...... 36 ANNEX 2: LETTER OF DEVELOPMENT POLICY FROM DADUKOU DISTRCT GOVERNMENT ...... 37 ANNEX 3: LETTER OF DEVELOPMENT POLICY FROM CHONGQING MUNICIPAL GOVERNMENT ...... 47 ANNEX 4: IMF ARTICLE IV CONSULTATION MISSION STATEMENT ...... 52
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Chongqing‐Dadukou District Fiscal Sustainability Development Policy Financing was prepared by an IBRD core team led by John Litwack (TTL, Lead Economist, GMF02) and Min Zhao (TTL, Senior Economist, GGO14) and consisting of Abha Prasad (Lead Economist, GMF13), Kai Kaiser (Senior Economist, GGO14), Karlis Smits (Senior Economist, GMF02), Christoph Ungerer (Economist, GMF02), Luan Zhao (Economist, GMF02), Yunxia Chao (Consultant), Juan Pradelli (Senior Economist, GMF03), Alejandro Alcala Gerez (Senior Counsel, LEGES), Regis Cunningham (Senior Financial Management Specialist, GGO20), Zhuo Yu (Finance Officer, WFALN) and Yu Shang (Program Assistant). The extended team also included Jay‐Hyung Kim (Advisor, GGO25), Chunlin Zhang (Lead Private Sector Development Specialist, GTC02), Haixia Li (Senior Financial Management Specialist, GGO20), Garo Batmanian (Lead Environmental Specialist, GEN02), Chongwu Sun (Senior Environmental Specialist, GEN02), and Lin Yang (Program Assistant). Important inputs came from Lili Liu (Peer Reviewer, Lead Economist, GGO14), Binyam Reja (Peer Reviewer, Lead Transport Specialist, GTI02), Da Zhu (Peer Reviewer, Senior Economist, GSU08), Roland Clarke (Peer Reviewer, Program Leader, LCC5C), Volker Treichel (Peer Reviewer, Lead Country Economist, GMF06), Nikola L. Spatafora (Lead Economist, EAPCE), Peter G. Moll (Senior Economist, OPSPQ), Marinus Verhoeven (Lead Economist, GGOPS), Nicola J. Smithers (Lead Specialist, GGO14); Mr. Bert Hofman (Country Director, China), Carlos Felipe Jaramillo (Senior Practice Director, GMFDR), Deborah Wetzel (Senior Practice Director, GGODR), Satu Kristiina Kahkonen (Ex‐Director, GMFDR), James Brumby (Director, GGOPS), Mathew Verghis (Practice Manager, GMF02), Robert Taliercio (Practice Manager, GGO14) provided guidance throughout preparation.
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SUMMARY OF PROPOSED LOAN AND PROGRAM
PEOPLE’S REPUBLIC OF CHINA CHONGQING‐DADUKOU DISTRICT FISCAL SUSTAINABILITY DPF PROGRAM Borrower People’s Republic of China Implementing Agency Chongqing Municipality Finance Bureau (CMFB) and Dadukou District Government Financing Data IBRD Loan Amount: US$200 million Terms: 24‐year maturity and 10‐year grace period Operational Type Stand‐alone single tranche development policy operation Program Development This Chongqing‐Dadukou District Development Policy Financing (DPF) Objective (s) And Pillars of supports Chongqing‐Dadukou District Government in achieving fiscal the Operation sustainability through a forward‐looking, comprehensive and transparent public finance framework that integrates budget, public investment and debt management. The three pillars of the DPF are: (a) Fiscal Sustainability; (b) Integrated Capital Investment Plan; and (c) Transparency. Results Indicators (Baseline: A. Developing and employing a medium term fiscal / debt sustainability 2015; Target: 2016) framework and budget for managing risks and ensuring the fiscal sustainability of Dadukou’s public finance A1: Dadukou District financing gap a share of District GDP (Baseline: 8.1% in 2015; Target: < 3.5% in 2016)
B: Developing an integrated approach to capital budgeting to improve efficiency B1: Dadukou executed outlays on investment projects in 2016 (Baseline: 1.79 billion RMB in 2015; Target: < 1.1 billion RMB in 2016) B2: Variance of executed investment in Dadukou District with capital investment plan (Baseline: 0.514 in 2015; Target: < 0.4 in 2017)
C: Enhancing transparency and accountability in the use of budget resources C1: Annual report on public sector assets and liabilities for on official website (Baseline: No in 2015; Target: Yes in 2016). C2: Share of projects executed by Jinqiao and Dasheng that correspond to explicit commissioned contracts (Baseline: 9%, in 2015 Target: >30% in 2016) Overall risk rating Substantial Climate and disaster risks Not applicable Operation ID P157404
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IBRD PROGRAM DOCUMENT FOR A PROPOSED CHONGQING‐DADUKOU DISTRICT FISCAL SUSTAINABILITY DPF PROGRAM TO THE PEOPLE’S REPUBLIC OF CHINA
1. INTRODUCTION AND COUNTRY CONTEXT
1. This single tranche stand‐alone development policy financing (DPF) for the equivalent of US$ 200 million supports Chongqing Municipality and Dadukou District in their quest to put the finances of Dadukou on a solid and sustainable path. It supports a program under which Dadukou District is adopting a Medium Term Fiscal Strategy and an integrated investment program aimed at rationalizing public investment and achieving fiscal sustainability. In this context, it is adjusting public investment policies. Dadukou District is also pioneering higher standards of transparency. The hope is that Dadukou District can become a model for budget reform in other local governments in China.
2. China is now a high middle‐income country, and well positioned to become a high income country in the next decade. The country’s economic transformation over the past three decades has raised living standards and made China the world’s largest manufacturer and exporter. Real per capita incomes increased 16 times over 1978–2014, and more than 750 million people have been lifted out of poverty. All Millennium Development Goals have either been reached or are within reach.
3. China’s exceptionally rapid growth and development in recent decades has served the country well, but can also be associated with economic, environmental and social imbalances. China’s leadership recognizes that the transition to a high income country requires a qualitatively new growth strategy that is more balanced, based on productivity increases and innovation, as opposed to the mobilization of resources and cheap unskilled labor. Growth also needs to become more inclusive and environmentally sustainable.
4. China’s growth has gradually slowed in this period of transition, signaling what President Xi Jinping has called the “new normal.” Growth has moderated from the 10 percent average annual rate that China experienced for three consecutive decades, falling to 7.7 percent in 2013, 7.3 percent in 2014, and 6.9 percent in 2015. Against this backdrop, China’s economy is steadily rebalancing toward more consumption‐led growth concentrated in the service sector.
5. While growth in China still remains high by international standards, macroeconomic risks have increased, including in the form of rapidly rising debt. To stimulate economic growth since the global financial crisis of 2008, subnational governments in China rapidly accumulated debt. Although subnational governments were not allowed to incur explicit deficits or borrow funds directly until 2015, they nevertheless accumulated debt quite rapidly in off‐budget local government financing vehicles (LGFVs), mostly Urban Development Investment Corporations (UDICs)) that carried out public investments. Local governments effectively collateralized borrowing through LGFVs with land lease revenues. In recent years, a number of local governments have begun to experience financial difficulties due to this rapid build‐up in LGFV debt against the backdrop of an economic slowdown, declining marginal returns from investment, and weaker land markets.
6. The Chinese Government has recognized the seriousness of this problem, and introduced a major reform in 2014 to bring subnational debt under control and reorient subnational officials and budgetary institutions toward fiscal / debt sustainability. Strong incentives at the subnational level of government to promote growth and investment have been an important ingredient of China’s successful 7 economic development in recent decades. The budget reform seeks to alter the incentives and constraints of subnational governments toward the additional objective of fiscal sustainability, while also improving transparency in local finance. Going forward, the reform prevents local governments from acquiring additional debt or issuing guarantees through LGFVs. At the same time, subnational governments have been granted the right to borrow explicitly through bond issues, albeit within strict limits. A bond swap program is addressing the stock problem of accumulated legacy debt in the LGFVs.
7. Chongqing Municipality and Hunan Province were chosen as regions to pilot World Bank development policy financing operations focused on budget reforms to achieve fiscal sustainability at the subnational level. The Chinese Government selected Chongqing and Hunan as the pilot regions for World Bank development policy operations for a number of reasons, including the strong reformist orientation of the municipal (provincial) leaderships and the strong demand in those regions for cooperation with the World Bank to accelerate reforms. To the degree that these initial subnational development policy financings are successful, they may be used subsequently as models for other regions in China. Important differences in context between the two pilot programs supported a decision to launch two separate operations. This particularly concerns differences between provincial‐level finance in Hunan and district‐level finance that is highlighted in the Chongqing operation.
8. Given the particular importance of local level finance for the success of the Budget Reform, Chongqing Municipality has chosen to concentrate this World Bank Development Policy Financing for US$ 200 million in the single pilot local government of Dadukou District in Chongqing Municipality. Chongqing is one of the four municipalities in China that has an elevated status equivalent to that of a province. The municipality comprises of 21 urban districts, 13 counties and 4 autonomous counties. Its total population is 30.2 million, with 18.4 million people in urban areas (2015). Dadukou is one of the nine central districts in Chongqing Municipality. The District has 330 thousand people and, like most other local governments in China, experienced a very rapid build‐up of LGFV debt in recent years. Particularly given important differences between province‐level and district‐level finance in China, it was also decided that this operation should stand alone separately from the concurrent development policy financing in Hunan Province.
9. Dadukou District faced a particularly challenging economic situation when its primary source of growth and employment, a large steel factory, was relocated to another part of Chongqing to comply with the new municipal zoning plan. Dadukou has been undergoing a difficult transition to a service‐ oriented economy that houses an industrial park. By 2015, accumulated debts recognized as the direct responsibility of the government amounted to the equivalent of 66 percent of local GDP. The vast majority of these debts were contracted by the Dadukou UDICs.
10. This Development Policy Operation assists Dadukou District develop the policies and institutions to achieve fiscal sustainability, greater efficiency in public investment, and enhanced transparency. With the assistance of the World Bank DPF, Dadukou is equipping itself with tools of debt sustainability analysis (DSA) to account for on‐ and off‐budget obligations and risks. A Medium Term Fiscal Strategy and integrated public investment plan are anchoring public expenditures and contingent liabilities to appropriate ceilings for fiscal sustainability and better prioritizing projects. These are new institutions at the local level of government in China, where on and off‐budgetary public investment is typically planned in an intricate and largely uncoordinated manner, without a comprehensive assessment of the implications for debt sustainability. As part of this operation, Dadukou District will also adopt disclosure requirements for its public investment programs and financial / debt position that go well beyond the current standards in China. This includes information valuable to the Chongqing Municipal Administration for the effective monitoring and regulation function envisioned in the budget reform. 8
11. Several possible forms of assistance were discussed with the Chinese Government, Chongqing Municipality, and Dadukou District before deciding on development policy financing. One possibility would have been to provide technical assistance without an operation. The World Bank has already engaged at the subnational level in China on budgetary reforms through technical assistance in Shanghai. The Chinese Government and World Bank agreed that a Development Policy Financing would be an appropriate vehicle for a deeper engagement for two primary reasons. First, experience in other countries such as Brazil and Nigeria with development financing suggests that a DPF can be an effective instrument for World Bank support to a comprehensive policy / reform program consistent with fiscal sustainability at the subnational level that goes beyond a technical assistance program. As evidenced by the substance of this operation, the DPF has indeed provided a framework for a new level of World Bank engagement at the subnational level in China. A structured program built around prior actions and results indicators has served to focus energies and World Bank assistance on common ambitious objectives. Second, given the complicated financial situation in Dadukou District, the relatively cheap and longer‐term financing provided by the DPF can alleviate some of the burden of the necessary short term fiscal adjustment. The deeper subnational engagement supported by this operation, as well as the simultaneous pilot in Hunan Province, should also enable the Bank to expand its cooperation with the Central Government and other subnational governments in the areas of budget reform and fiscal sustainability.
12. A multi‐tranche operation was also considered. Given that this operation supports institutional reforms that will take time to be realized, a programmatic engagement was naturally discussed. The Chinese Government decided that it would prefer to evaluate the results from this first DPF before considering options for further support which could be to Chongqing or for expanding the program to other provinces. While this operation is a stand‐alone single tranche operation, it is envisioned that cooperation between the World Bank, Chongqing Municipality, and Dadukou District will continue beyond the initial DPF in one form or another.
13. There are significant risks to the operation. This is one of two first World Bank development policy financing operations in China, and the first World Bank DPF at the district level of government. Key risks to this operation include: (a) limited institutional capacity in Dadukou District; (b) macroeconomic uncertainty in China; and (c) general uncertainty over the future course of the budget reform. The first risk is being mitigated through extensive technical assistance. For the second and third risks, there is a significant degree of prudence and flexibility embodied in the DPF program, and Dadukou is committed to adjusting its program as necessary on an annual basis to maintain a fiscally sustainable path.
2. MACROECONOMIC POLICY FRAMEWORK
2.1 RECENT ECONOMIC DEVELOPMENTS IN CHINA
14. China’s economic growth has continued to moderate. During the recent 12th Five Year Plan, GDP expanded by 7.8 percent per year on average, as compared to the 10 percent annual average growth rate that China experienced for three consecutive decades. Growth in 2016 is projected to be about 6.7 percent, in line with the government’s indicative growth interval of 6.5 to 7.0 percent, but down from 6.9 percent in the previous year.
15. The deceleration of growth reflects weaknesses in traditional industrial activity, as China rebalances to more service‐oriented growth. Excess capacity in manufacturing has been a drag on growth and investment across a wide range of sectors. The producer price index turned negative in 2014 and continued to decline until very recently, reflecting both lower commodity prices and considerable 9 industrial overcapacity. At the same time, healthy growth of consumer spending and services has helped China maintain still strong growth rates, and is in line with the rebalancing sought by policymakers. The service sector continues to experience rapid growth of over 8 percent in recent years.
16. Despite the deceleration of GDP, employment and income have exhibited robust growth. More than 13 million new urban jobs were created in 2015, exceeding the 10 million annual target. Moreover, household real disposable income per capita grew by 7.4 percent. The World Bank poverty estimate for 2013 is 1.9 percent of the population, and it appears that the rate has fallen further in more recent years.1
17. In the context of rebalancing, China’s current account surplus has narrowed considerably, but strengthened again in 2015. China’s current account exhibited a surplus of 2.7 percent of GDP in 2015, which is much less than 10 percent of GDP in 2007, but stronger than 2 percent of GDP in 2013 and 2014. Weaker export and stronger import growth narrowed China’s current account in recent years. In 2015, weaker commodity prices contributed to exceptionally low import growth, thus strengthening the trade balance and the current account. Exports declined by 2.9 percent in US$ value terms, but imports fell by 14.2 percent.
18. Despite a record trade surplus, significant capital outflows pushed China’s external balance into deficit in 2015 and early 2016. Gross capital outflows (excluding foreign direct investment) from China reached an estimated US$ 760 in 2015 and significant outflows continued into early 2016. Consequently, despite the strong current account, gross foreign exchange reserves declined by US$ 513 billion (20 percent) in 2015 and US$ 125 billion in the first half of 2016.
19. Much of the recent strong capital outflows from China can be explained by temporary factors. The real appreciation of the RMB attracted significant short term capital inflows to China through early 2014. Now that real appreciation is no longer expected, much of this speculative capital left the country, in part through Chinese banks winding down their foreign exchange exposure. Second, uncertainty in markets around exchange rate policy in light of a depreciation of the RMB against the US dollar in the second half of 2015 encouraged some investors to reduce their exposure to RMB. Chinese authorities have moved away from the dollar to a trade‐weighted basket of currencies for orienting exchange rate policy. While the RMB depreciated by 7 percent against the US dollar in the second half of 2015, it remained broadly stable against the relevant basket of currencies. Clearer communication from Chinese authorities on exchange rate policy has helped reduce volatility on the forex market and capital outflows may be stabilizing. This is reflected in a stabilization in China’s gross foreign reserves since the second quarter of 2016.
20. Macroeconomic policy loosened in 2015 and early 2016 in an effort to prevent too rapid an economic slowdown. The People’s Bank of China (PBOC) continued to lower benchmark interest rates and required reserve ratios, while implementing new policies to facilitate refinancing for commercial banks. The fiscal deficit of the Government widened to a six‐year high in 2015 of 2.3 percent of GDP. This partly reflects accelerated infrastructure investment by the Central Government in the second half of the year to offset cutbacks by local governments related to falling land‐lease revenues and new restrictions on off‐budgetary investments imposed by the budget reform.
1 This estimate uses the new World Bank poverty line of US$ 1.90/day and the new purchasing power parity exchange rates based on 2011 prices. 10
Table 1: China / Selected Economic and Social Indicators, Projections 2013‐2018 2013 2014 2015 2016 f 2017 f 2018 f Real GDP Growth, at constant market prices 7.8 7.3 6.9 6.7 6.5 6.3 Private Consumption 6.8 7.9 7.6 7.5 7.4 7.3 Government Consumption 7.1 6.9 7.9 8.0 8.2 8.3 Gross Fixed Capital Investment 9.3 6.9 6.9 6.5 6.1 5.6 Net exports (contribution to annual growth in percent) ‐0.4 0.1 ‐0.1 ‐0.3 ‐0.4 ‐0.4 Export, Goods and Services 4.0 5.4 ‐2.0 1.2 2.3 3.0 Import, Goods and Services 4.6 4.0 ‐1.3 2.1 3.3 4.1
Real GDP Growth, at constant factor prices 7.8 7.3 6.9 6.7 6.5 6.3 Agriculture 3.8 4.1 3.9 3.7 3.6 3.5 Industry 8.0 7.4 6.1 5.8 5.5 5.2 Services 8.2 7.7 8.4 8.0 8.0 7.9
Consumer Prices (Consumer Price Index) 2.6 2.0 1.4 1.8 2.0 2.1
Aggregate Financing (growth) 17.5 14.3 14.0 … … … Aggregate Financing ( % of GDP) 182.7 193.2 204.1 … … …
Employment and Poverty Unemployment Rate 4.1 4.1 4.1 … … … Poverty line $1.90 a day 1.9 1.5 1.1 0.8 0.6 0.5 Poverty line $3.10 a day 11.1 9.5 7.7 6.2 5.0 3.9
Balance of Payments ( % of GDP) Current Account Balance 1.5 2.6 3.0 3.0 3.1 3.3 Financial and Capital Account ‐0.9 ‐1.6 ‐1.6 ‐1.7 ‐1.9 ‐2.0 Net Foreign Direct Investment 2.3 1.4 1.4 1.4 1.3 1.3 Gross External Debt 9.0 8.5 12.9 … … …
Public Sector finance ( % of GDP) Fiscal Balance ‐2.0 ‐2.1 ‐2.4 ‐3.0 ‐3.3 ‐3.3 Government Direct Debt … 38.8 38.9 … … …
Real Effective Exchange Rate (end of period, annual 7.6 6.1 3.8 … … … growth in percent)
Sources: CEIC, Wind and World Bank staff estimates and projections
21. The growth of aggregate financing—a broad measure of outstanding credit to the non‐ government sector—increased in the second half of 2015 and early 2016, reversing a recent trend of deceleration. This has stimulated activity in the short‐term, but arguably delayed the needed deleveraging of highly‐indebted entities. Aggregate financing growth in 2015 registered at 14 percent, still well above nominal GDP growth, and is planned for 13 percent in 2016. Growth in aggregate financing accelerated to an estimated 13.4 percent in the first quarter of 2016 year‐on‐year. Credit to the non‐government sector is now well over 200 percent of GDP, which is high by international comparisons. Government debt has also grown very quickly over the past decade. Consolidated direct government debt stood at 39.4 percent of GDP at the end of 2015.2 Even adding contingent liabilities emanating from public‐investment
2 Using the latest revised GDP number by National Bureau of Statistics, the direct government debt to GDP ratio would be lowered to 38.9 percent. 11 related corporate liabilities, government debt to GDP is still not that high by international standards. However, the continued rapid expansion in credit is increasing macroeconomic risks in China.
2.2 MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY IN CHINA
22. China’s GDP growth rate should continue a gradual decline in the medium‐term in the context of structural adjustments and policy efforts to address accumulated vulnerabilities (Table 1 above). Growth is expected to decelerate to 6.7 percent per year in 2016. The average annual growth rate during the 13th Five Year Plan period (2016‐2020) is projected to be about 6.5 percent. The rebalancing toward domestic demand will continue. Investment growth is expected to moderate from current very high levels, while consumption and employment growth will remain robust. On the supply side, the shift from capital and resource‐intensive industries to services will continue, facilitated by policies to ease business regulations in the services sector and rationalize excess capacity in industrial sectors. Growth in services is expected to outpace that in manufacturing and contribute to more than half of GDP growth by 2020.
23. There is considerable uncertainty around the baseline projections for China’s economy. First, a more rapid deceleration in economic growth is a distinct possibility. Second, risks from the credit expansion could potentially manifest themselves in some future financial stress or instability. This could accelerate the slowdown in investment and the tightening of credit conditions, thus negatively affecting growth and rebalancing. The pace of reforms and policies in China to support economic rebalancing and bring the credit expansion under control will be important for mitigating these risks.
24. China is confident that it still has significant buffers for conducting active macroeconomic policy. These buffers include public debt at still less than 60 percent of GDP and gross foreign exchange reserves of US$ 3.2 trillion at end‐March 2016. However, these buffers could diminish over time, thereby increasing macroeconomic risks and reducing the degrees of freedom for policymakers.
25. A debt sustainability analysis (DSA) conducted for China in 2016 by the IMF concluded that the risk of debt distress is low, given China’s macroeconomic strength and favorable debt profile, although public debt according to a broad definition is on a rising path. The IMF employs a broad measure that includes central government debt, debts of subnational governments, and the estimated debts of local government financing vehicles.3 It is roughly equivalent to the concept of “government debt plus public benefit state owned enterprises (PBSOE) liabilities” used in section 2.3 below for the subnational debt sustainability analysis. It should be noted that this measure represents an upper bound for fiscal obligations of the government. Some of these contingent liabilities will likely not end up as government obligations. The focus on gross debt also ignores the fact that government in China has considerable state assets and sizeable equity holdings, many of which are listed on domestic and international stock exchanges.
26. In the baseline scenario, the IMF estimates that broadly‐defined public debt is on a slightly rising path, and a contingent liability shock could adversely affect the picture. The baseline scenario in the IMF debt sustainability analysis has annual GDP declining and converging to about 6.0 percent by 2021. Growth in expenditures at the subnational level also gradually declines, thereby generating smaller deficits, along with the implementation of the budget reform. In the baseline scenario, public sector debt edges upward from 55 percent of GDP in 2015 to about 74 percent in 2020. The DSA finds that these
3 This IMF measure is controversial and not accepted by the Chinese government. Assessing the true implied contingent obligations for government from public investment related debts held by local government financing vehicles remains difficult. 12 results are generally robust to small shocks to GDP growth, but a contingent liability shock that envisages 10 percent of banking sector assets becoming government liabilities, would push public debt almost as high as 100 percent of GDP by 2020. (Figure 1)
Figure 1: IMF Debt Sustainability Analysis of Broadly Measured Public Sector Debt, 2016
Source: IMF Country Report No. 16/270
27. On the basis of the above discussion, China’s macroeconomic policy framework is deemed adequate for the operation. China has been conducting largely responsible fiscal and monetary policies. The upper bound on government obligations remains within a manageable range under baseline and stress tests. China’s overall debt profile is also favorable, as the vast majority of public debt is financed through a domestic investor base in the national currency. Over the medium and longer term, China will need to give attention to preventing excessive government debt accumulation, particularly given that non‐government debt is quite high.
2.3 THE SUBNATIONAL CONTEXT
2.3.1 Recent Economic Developments in Chongqing Municipality
28. Chongqing Municipality is among the fastest growing regions in China. Its average GDP growth rate of 12.8 percent during 2011‐2015 well exceeded the national average of 7.8 percent. Chongqing has a GDP of 1.57 trillion RMB and a population of 30.2 million (2015). GDP per capita in Chongqing is slightly above the Chinese average. The regional economy is concentrated in the secondary and tertiary sectors, which accounted for 45 percent and 48 percent of GDP in 2015, respectively. Gross fixed capital formation comprises 54 percent of GDP (2014), which is even greater than the already high 46 percent for China as a whole. Consistent with recent trends in much of China, the pace of economic growth in Chongqing Municipality has decelerated in recent years (Figure 3), while the share of the tertiary sector in GDP has increased from 36 percent in 2011 to 48 percent by 2015.
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Figure 2: Chongqing GDP decomposition by Figure 3: GDP growth in Chongqing Municipality sector (2015) and China (%) Primary 20 Industry, Tertiary 7.3% 15 Industry, 47.7% 10
5
0 2001 2003 2005 2007 2009 2011 2013 2015 ‐5 Secondary Industry, GAP Chongqing China 45.0% Source: World Bank staff calculations based on CEIC data. 29. Total government debt in Chongqing Municipality is higher than average among Chinese Provinces. Chongqing’s rapid development with massive infrastructure investment has led to the accumulation of significant government debt. Data from the latest National Audit (July‐2013) on “Total government debt” (Figure 4), including direct government debt and also guarantees and identified contingent liabilities, as well as more recent data, confirm Chongqing’s elevated debt status among Chinese provinces. Chongqing’s vibrant economy and strong growth track record remain fundamental to the sustainability of its finances.
Figure 4: Total Government Debt in Chinese Provinces GDP (mid‐2013, share of GDP) 80 70 60 50 40 30 20 10 0 Jilin Hebei Anhui Hubei Fujian Henan Shanxi Hunan Jiangxi Tianjin Beijing Hainan Jiangsu Jiangsu Ningxia Yunnan Shaanxi Qinghai Sichuan Xinjiang Guangxi Guizhou Liaoning Zhejiang Shanghai Shandong Chongqing Neimenggu Guangdong Heilongjiang
Source: World Bank staff calculations based on China Audit Reports (2013).
30. Chongqing’s GDP growth is expected to converge towards the national trend as the Municipality continues its ongoing structural transformation. For the 13th Five Year Plan, Chongqing authorities target ambitious annual average GDP growth of 9 percent. However, as exceptionally high rates of public investment have begun to yield diminishing returns to growth in Chongqing, the pace of GDP expansion
14 should continue to moderate during a period of structural shift toward services and consumption‐led growth. In this context, Chongqing Municipality will need to manage effectively the debt that it has accumulated. Around 50 percent of debt in Chongqing Municipality corresponds to the local level of government. Thus, the type of program being developed in Dadukou District, if scaled up to other local governments, can be of potential high value for the Municipality as a whole for meeting future fiscal challenges.
2.3.2 Dadukou District and Fiscal Sustainability
31. Dadukou District has been managing an abrupt economic transition. Dadukou is an urban district of Chongqing Municipality with 330,000 residents and GDP of RMB 16.0 billion in 2015. The District’s economy previously revolved around a large steel factory. However, in 2011, a tightening of environmental standards for the central part of Chongqing forced the relocation of the steel plant to another part of the Municipality. While this relocation can be associated with significant environmental improvements for central Chongqing, it also caused an initial sharp contraction in Dadukou’s nominal GDP by close to 30 percent.
32. The District Government has taken decisive steps towards rebuilding Dadukou’s economic base, leading to a strong recovery in 2013‐2015. The land vacated by the steel plant was converted into the Jianqiao Industrial Park, and the District Government has pursued an ambitious program of public investment and land development that is focused on the IT sector, tourism, environmental protection technology, and residential housing. In this context, GDP growth rebounded strongly (Figure 5). The new growth has been concentrated in Dadukou’s tertiary sector (Figure 6).
Figure 5: Dadukou Nominal GDP Growth (%) Figure 6: Dadukou GDP decomposition by sector (2015) 25 Primary Industry Secondary 20 1% Industry 40% 15
10
5
0 2009 2010 2011 2012 2013 2014 2015 ‐5
‐10 Tertiary ‐15 Industry 59% ‐20
Source: World Bank staff calculations based on CEIC data.
33. Dadukou authorities target 9 percent average growth during 2016‐2020, although this projection is subject to significant risk. Services now dominate the District’s production base, and future growth will depend greatly on the continued success of Dadukou in attracting private investment to this sector. As in much of China, there are now signs of an economic slowdown in Dadukou. In particular, new land leasing has fallen far short of targets in 2015 and early 2016. The quite difficult fiscal position of Dadukou District, as described below, will limit the size of public investment in the near future, which is 15 also consistent with more moderate growth. The recent dynamism of the local Dadukou economy gives reason to hope that growth will remain well above the national average in the immediate future, but there are significant risks of a sharper slowdown in growth going forward.
Box 1: Government Debt and Non‐Government LGFV Debt in China
Until 2015, subnational governments in China were not allowed to borrow themselves, and instead set up off‐budget local government financing vehicles (LGFVs, mostly UDICs), to borrow for public projects with implicit government guarantees effectively collateralized by future expected land revenues. LGFVs typically finance themselves from budget transfers (often land revenues) and implement public projects. For the implementation of the budget reform, the Chinese Government carried out an inventory of the LGFVs debt stock in 2014. Debts incurred for public projects without expected revenue sources were categorized as direct government debt. Other debts in the LGFVs were usually categorized as commercial (non‐government) debt. In light of the revision of the Budget Law in 2014 that prohibits governments from borrowing through LGFVs. LGFVs are to be dissolved or transformed to state owned enterprises (SOEs). All new debts incurred by these firms since 2015 are categorized officially as strictly “commercial (non‐government) debt” with no official repayment obligations for government. In general, the successors of LGFVs that play significant role in providing public benefit goods and services are recognized as public benefit SOEs (PBSOEs). They have continued to be very active in public projects in 2015 and early 2016, and have continued to borrow significantly. While this borrowing is no longer officially considered the liability or contingent liability of government, the fact that the finances of government and PBSOEs in many localities remain intertwined in complicated ways implies remaining risks. This is why Dadukou has taken a prudent approach to analyzing fiscal sustainability that includes both government debt and all liabilities of the PBSOEs.
34. High levels of public investment and the relocation of the steel plant have created a heavy debt burden for Dadukou District. As of 2015, the direct government debt of Dadukou District stood at 10.5 billion RMB, equivalent to 66 percent of local GDP or 170 percent of local revenues. In addition to this direct debt, Dasheng and Jianqiao, the two UDICs in Dadukou, have significant additional commercial liabilities (debt and payables), many of which are tied to land development. The total liabilities in Dadukou related to public investment, including direct government debt and the commercial liabilities of the UDICs, stood at RMB 25.4 billion in 2015, which amounted to 159 percent of local GDP.
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Table 2: Budget Projections for Dadukou Under the Baseline Scenario, billion RMB
Source: staff projections
35. Under the Dadukou fiscal adjustment program, described further below in section 3, direct government debt falls to 89.3 percent of budget revenues by 2025 (or 22.2 percent of GDP) in the baseline scenario. The baseline scenario is based on current projections of Dadukou District. Under this scenario, local GDP growth remains strong, but moderates over time, gradually slowing from 9.6 percent in 2016 to 6 percent in 2025. Increased sharing of municipal land‐lease revenues with Dadukou District strengthens the budget from 2016 onwards (Table 2). In addition, an expected recovery in the local land market allows for an acceleration in District land lease revenues starting in 2017. The District will target stable public investment at around 1.1 billion in 2016‐2020 and make use of PPP‐financing arrangements where possible. In this scenario, direct government debt will decline to 89.3 percent of local revenues by 2025 (Table 3). Dadukou District also will make strong efforts to attract outside investment with the goal of bringing direct government debt under 100 percent of local revenues at an earlier date than in the baseline scenario.
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Table 3: Change in Dadukou Government Debt in the Baseline Scenario, billion RMB (bn RMB) 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 (Actual) (Budget) (Forecast) Annual net change in direct government debt [-A+B+C] -1.4 0.0 -1.2 -0.2 -0.4 -0.4 0.0 0.0 -0.1 -0.1 -0.2 % change rel. to previous year -11.5 -0.4 -11.0 -2.2 -4.1 -4.3 0.2 -0.2 -0.6 -1.3 -1.9
(A)Primary fiscal balance [a+b+c] 2.1 0.6 1.6 0.6 0.7 0.7 0.3 0.3 0.3 0.4 0.4 (a) Primary budget balance (/1) -0.1 0.6 1.6 0.6 0.7 0.7 0.3 0.3 0.3 0.4 0.4 (b) Land Reserve Center balance -0.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 (c) UDIC contribution 2.5 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 (B) Interest 0.9 0.6 0.4 0.4 0.3 0.3 0.3 0.3 0.3 0.3 0.3 (C) Change in carry-over (/2) -0.2 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Memo: Stock of direct government debt 10.5 10.5 9.3 9.1 8.8 8.4 8.4 8.4 8.3 8.2 8.1 % of GDP 65.9 60.4 49.5 44.5 39.2 34.4 31.6 29.0 26.6 24.4 22.2 % of total budget revenues 169.9 159.7 133.8 131.3 129.1 118.8 115.7 110.5 106.2 96.4 89.3 Debt service of direct government debt 3.6 2.9 2.2 1.4 3.0 1.8 3.2 2.4 2.5 3.9 % of GDP 21.0 15.4 10.9 6.4 12.3 6.9 11.1 7.6 7.3 10.8 % of total budget revenues 55.4 41.6 32.0 21.2 42.4 25.3 42.2 30.3 28.7 43.3 (/1) Primary budget balance excludes budget net borrowing & change in carry-over (/2) Change in carry-over assumed to be 0 in the projection Source: staff projections
36. Dadukou focuses its fiscal sustainability analysis on the public liabilities of the District, including direct government debt, the commercial liabilities of the UDICs, and contingent liabilities from PPPs. Given the fact that Dadukou’s public finances remain at present intertwined with those of the UDICs in complicated ways, the District Administration understands that the commercial liabilities of the UDICs can be associated with contingent liabilities for Dadukou. The future liabilities of PPPs will also entail contingent liabilities going forward. To account for these liabilities in a prudent manner, Dadukou District has carried out a fiscal sustainability analysis to ensure that the public liabilities of the District, including commercial liabilities of the UDICs and expected liabilities of PPPs, will stabilize under the baseline scenario as well as in a stress test of this scenario. The baseline comprehensive analysis projects that the district UDICs will continue to access commercial finance at an average of 8 percent interest. The stress test (weaker macro) projects GDP growth for the District at two percentage points lower than in the baseline, while land lease revenues are 20 percent lower.4 This stress test is particularly important as there is significant downside risk to Dadukou District’s quite ambitious expectations of future land lease revenues, even accounting for the agreement with Chongqing municipality on the new revenues that will come from the municipal‐level UDICs working in Dadukou. As illustrated in Figure 7, under the proposed fiscal adjustment program, the public liabilities in the District can be expected to decline under the baseline scenario from 159 percent of local GDP to 91.3 percent by 2025. Under the stress test, the public liabilities also decline, although at a slower pace, and stabilize at around 130 percent of local GDP.
4 Other downside risks to the projections include higher than projected UDIC refinancing costs, higher than expected land‐lease preparation costs of the UDICs or higher than expected investment operating and maintenance costs. 18
Figure 7: Dadukou District Debt Sustainability: Baseline and Downside Scenarios (Public Liabilities as a Percentage of District GDP)
Source: staff projections
37. The commitment of Dadukou District to a program consistent with fiscal sustainability makes the local budgetary and macro framework adequate for this operation. Given the high level of government debt and the public liabilities in Dadukou District, combined with significant uncertainty concerning growth and land revenues, the risks to the fiscal framework are very high. Nevertheless, Dadukou has undertaken a program to manage these risks effectively, and ensure fiscal sustainability under a plausible range of future scenarios.
2.4 INTERGOVERNMENTAL RELATIONS
38. China’s intergovernmental system is characterized by a high level of decentralization in expenditures, although tax rates and many expenditure responsibilities are determined by the Central Government. China’s inter‐budgetary system consists of the central government and 34 province‐level divisions. The provincial level also typically consists of several layers of authority, i.e. prefecture‐level cities, districts and counties, and townships. Tax revenues are shared between different levels of governments. In addition, significant shares of revenues are transferred from the Central Government to provinces, and from provinces to local governments, both in earmarked and general forms. These transfers are generally adequate to cover the gap between revenues and current expenditures at the subnational level. Subnational governments finance investment largely through borrowing and revenues from land. Until 2015, subnational governments could not borrow explicitly, but have borrowed significantly off budget through LGFVs, effectively using future land revenues as collateral. Since 2015, the Budget Reform allows explicit subnational borrowing for the first time for investment finance, while restricting the former off‐ budgetary schemes.
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39. Dadukou Government’s direct debts are subject to strict scrutiny and control of upper‐level governments and the District People’s Congress. The 2014 reform of the Budget Law, effective as of January 1, 2015, as well as subsequent State Council decisions formalize subnational government bond issuance subject to annual quota restrictions. Only provincial level governments (including Chongqing Municipality, which is one of four Municipalities equivalent to a province) are allowed to borrow exclusively through issuing local government bonds. The Golden Rule applies, restricting all debt revenues for the finance of capital expenditures. The Law also prohibits the Central Government from bailing out any subnational governments. The nation‐wide aggregate outstanding subnational debt (stock) and net debt financing (flow) require the approval of the National People’s Congress. Within these aggregate limits, the Ministry of Finance sets a debt ceiling for each province and closely monitors compliance, while provinces set debt ceilings for local governments within the overall limit. Dadukou borrows through on‐ lending arrangements with Chongqing Municipality, and within the ceiling set by the Municipality. Dadukou’s outstanding debt and net borrowing are subject to the approval of the District’s People’s Congress. Subnational governments are authorized to issue bonds to swap all off‐budget legacy government debt in three years as of 2015.
Table 4: Tax Sharing Arrangements between the Central, Chongqing and Dadukou District
Chongqing Dadukou Revenue Instrument Central Municipality District Consumption tax 100 0 0 Customs duty 100 0 0 Vehicle purchase tax 100 0 0 Enterprise income tax 60 24 16 Individual income tax 60 24 16 VAT on domestic production 75 15 10 Vehicle‐ and vessel‐use tax 0 100 0 Business tax (currently being integrated with the 0 60 40 domestic VAT) Urban maintenance and construction tax 0 60 40 Property tax 0 60 40 Resource tax (on inland resources) 0 0 100 Stamp tax 0 0 100 Urban and township land‐use tax 0 0 100 Farmland occupation tax 0 0 100 Land‐appreciation tax 0 0 100 Contract tax 0 0 100 Tabaco leaves tax 0 0 100 Source: Dadukou District Government
40. Tax‐sharing arrangements between the Central Government and Chongqing Municipality, as well as between Chongqing Municipality and Dadukou District, have been very stable. Table 4 presents the current tax sharing ratios between these three layers of government. Tax‐sharing arrangements between the Central Government and the subnational governments are governed by the State Council’s Decrees (No. 85, 1993 and No. 37, 2001), and those between the Chongqing and Dadukou by Chongqing Municipal Government’s Decree (No. 93, 2003). These sharing arrangements remained unchanged from 2004 until May 2016. Starting from May 1, 2016, the VAT replaced the former business taxes, and VAT revenues are now shared by the Central Government 50 to 50 with subnational governments. The VAT sharing arrangement between Chongqing Municipality and Dadukou District is yet to be announced. Dadukou could be adversely affected by the on‐going conversion of Business Tax to Value‐Added Tax,
20 particularly in the short run, but the potential revenue losses should be covered with a lump‐sum transfer from the Municipality.
41. In addition, Chongqing and Dadukou share net income from land leases in a 50:50 proportion. Of the three municipal entities that are involved in land development in Dadukou, only one entity actually shared the land revenues with Dadukou by end 2015. Chongqing Municipal Government adjusted the sharing arrangement of municipal entities’ land lease revenues in 2016. This adjustment is expected to bring additional 3 billion RMB in land revenues to Dadukou in 2016‐2020.
42. Going forward, the Chinese Government is examining reforms of the inter‐governmental fiscal system that could make local finance more sustainable. A primary challenge in Dadukou District and other local governments in China concerns the lack of autonomy in taxation combined with a high dependence on land lease revenues. Given that local governments have little control over their revenues outside land, and are constrained to realize most current expenditures according to centrally‐determined norms and regulations, a fiscal adjustment such as the one Dadukou is carrying out at present needs to focus almost entirely on public investment spending and land leases. A fundamental problem for long run sustainability going forward is that the supply of land is finite. Thus, when Dadukou has sold all of its available land, further investment spending could only be supported by different financial arrangements. It is expected that new arrangements (local tax and intergovernmental fiscal reform) should come into effect over the next decade or so.
43. Based on the above assessments and the adjustment Chongqing Municipal Government made to the sharing arrangement of land revenues, the current intergovernmental relations are deemed adequate for this operation.
3. THE DADUKOU DISTRICT GOVERNMENT’S PROGRAM
44. Dadukou District pursues two overarching development goals to: (1) promote the agglomeration of modern services and manufacturing and (2) accommodate more residents and provide them with good‐quality urban services. Dadukou District adopted a 13th Five Year Economic and Social Development Plan (2016‐2020) in line with the Chongqing Municipal Government’s Five Year Plan. As Dadukou falls into two different municipal zones, the functional core zone and the expanding zone, the north area and the south area of Dadukou are designated with somewhat different, but integrated, development goals. The goal of the north area is to upgrade its industry toward modern services, with a focus on finance, international business, and high‐end trade. The goal of the south region is to promote the agglomeration of newly emerging industries (including high‐end manufacturing) and to accommodate more people dispersed from the core zone as well as new migrants to Chongqing.
45. Dadukou anchors its development strategy to that of the Municipality, which consists of seven pillars: developing a new industrial structure by nurturing new industries such as environmental protection, information services and tourism, and also by upgrading traditional manufacturing along the value chain; improving development coordination through improved zoning and connectivity; promoting green development and making the city more livable; developing an open economic regime; making development inclusive and improving the accessibility and quality of public services; modernizing the governance regime and capacity; and ensuring implementation of the five‐year plan. Of these goals, the most relevant for this operation concerns governance modernization, which requires deepening reforms in various areas, including enhancing coordination in government policies, improving the fiscal risk/debt management framework, strengthening public investment and finance management, streamlining the
21 regulatory framework, promoting structural changes, and reforming State‐owned enterprises and public services units.
46. In light of the current difficult situation, responsible debt management and debt reduction occupy a central position in the priorities and programs of Dadukou District. In this context, the World Bank was invited by Chongqing Municipality and Dadukou District to cooperate on a program of reform in fiscal and budgetary management. Under this program, Dadukou is undergoing a fiscal adjustment according to a Medium Term Strategy that limits growth in the volume of public investment through integrated capital budgeting and better prioritization. The DPF program is more fully described in the next section.
47. To put the District on a path toward fiscal sustainability, the Dadukou Government has developed a Medium Term Fiscal Strategy (MTFF). This strategy freezes outlays on public investment expenditure at around RMB 1.1 billion per year over the 2016‐2020 planning period, thereby keeping public investment as a shrinking share of GDP: from 6.4 percent in 2016 to 4.5 percent in 2020. An integrated capital investment plan is used to prioritize the most important projects for the District’s development. Dadukou will also generate additional revenues through the accelerated sale of land leases. Sales were weak in 2015 and early 2016, but there are signs now that some local markets in China are picking up. On a national scale, land lease revenue growth turned positive in the fourth quarter of 2015. Chongqing Municipality is committed to supporting Dadukou District through enhanced sharing of land‐ lease revenues generated by Municipal UDICs in Dadukou. Finally, beyond the current debt swap program, Dadukou will aim to repay high‐interest debt early to reduce its interest burden. The combination of these measures will place Dadukou on a fiscally sustainable path under a suitable range of macroeconomic assumptions.
48. Going forward, Dadukou District plans to institutionalize recent budget reforms and further clarify the division of government and PBSOEs finances. Dadukou District has adopted decrees for the continual annual medium‐term budget planning on a rolling basis, including 3‐year rolling capital budgets, supported by a DSA analysis. In these areas, it plans to build additional capacity over the next few years. Dadukou will also continue the important reforms to transform non‐government parts of the two district UDICs into strictly commercial companies. The first steps of these reforms are in the DPF program.
4. THE PROPOSED OPERATION
4.1 OPERATION DESCRIPTION AND LINK TO GOVERNMENT PROGRAM
49. This Chongqing‐Dadukou District Development Policy Financing (DPF) supports Chongqing‐ Dadukou District Government in achieving fiscal sustainability through a forward‐looking, comprehensive and transparent public finance framework that integrates budget, public investment and debt management. The DPF program in Dadukou is divided into three pillars: fiscal sustainability, integrated capital investment plan, and transparency. Under the first pillar, Dadukou develops and employs a medium term fiscal / debt sustainability framework for assessing its fiscal space, managing risks, and ensuring the sustainability of its public finances. Under the second pillar, Dadukou is changing the nature of capital investment planning by adopting an integrated approach for rationalizing public investments within an appropriate ceiling for aggregate outlays. Under the third pillar, Dadukou is enhancing transparency and accountability in the use of budgetary resources through the adoption of standards for disclosure and regular information reporting. Dadukou is also taking important steps toward the transformation of the district UDICs into independent commercial enterprises. A number of the prior
22 actions for this operation focus on the Medium‐Term Fiscal Strategy and a three‐year rolling capital investment plan anchored to debt sustainability analysis.
50. Under this operation, Dadukou can serve as a pilot for local government fiscal reform in China by creating a forward‐looking, comprehensive and transparent public finance regime that integrates budget, public investment and debt management. If the District can become a successful pilot, this would have implications for the budget reform in China that go beyond Dadukou and Chongqing.
51. While this is the first subnational development policy operation in China, the project design is informed by the experience of such subnational operations in other countries, as well as from other types of operations in China. The World Bank has been accumulating experience from subnational development policy operations in several countries, including Brazil, India, and Nigeria. Some of these operations also focused on achieving or maintaining fiscal sustainability. Experience has confirmed that strong ownership of the operation is particularly critical to the success of development policy lending. The program being supported will have little meaning or impact if it is discontinued after the operation is over. In this regard, the operation is encouraged by the pride and determination of Dadukou District to transform itself from one of many fiscally‐distressed local governments in China into a positive example of a fiscal turnaround that could be followed by other localities. The technical assistance that accompanies this operation is focused, first and foremost, on transferring knowledge to Dadukou officials, who are carrying out the prior actions as genuine steps toward a permanent budgetary reform in the locality.
4.2 PRIOR ACTIONS, RESULTS AND ANALYTICAL UNDERPINNINGS
Table 5: DPF Prior Actions and Analytical Underpinnings Prior Actions Analytical Underpinnings
Operation Pillar 1: Fiscal Sustainability Prior action #1: The Government of Dadukou District has Urban China Flagship Report (2014), World Bank adopted and published a medium‐term fiscal strategy, Technical Note on Managing Transitional Risks (2015), grounded in a debt sustainability analysis, which sets a World Bank Policy Note on Subnational Debt target for district‐level public investment financing that is Regulatory Framework (2011), World Bank consistent with debt sustainability. cooperation with Dadukou District on debt sustainability analysis (2015). Prior action #2: The Government of Dadukou District has submitted to Dadukou District People’s Congress an Beyond Annual Budget Report (2013), China 2030 annual budget for 2016 that corresponds to a Medium‐ (2012), World Bank Policy Note on China MTEF (2013), Term Fiscal Strategy plan which is consistent with debt World Bank cooperation with Dadukou District on sustainability. MTFF (2015). Operation Pillar 2: Integrated Capital Investment Plan Prior action #3: The Government of Dadukou District has Urban China Flagship Report (2014), World Bank issued a three‐year rolling capital investment plan that is Technical Note on Municipal Infrastructure Planning consistent with the ceilings on public investment outlays in and Budgeting (2013). the Medium‐Term Fiscal Strategy for public investment projects during 2016, and for commitments made in 2016 for public investment outlays in the years 2017‐2018.
Prior action #4: The Government of Dadukou District has issued a decree that specifies the time frame and division World Bank cooperation with Dadukou District on of institutional responsibilities for the annual formulation capital investment plan (2015).
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of a three year rolling capital investment plan, beginning in 2016.
Operation Pillar 3: Transparency Prior action #5 The Government of Dadukou District has Urban China Flagship Report (2014), World Bank adopted a decree for regular annual disclosure of assets Policy Note on Transparency (2013), World Bank and liabilities of the public sector, including public benefit cooperation with Chinese Treasury Department on state–owned enterprises. subnational debt monitoring and reporting (2015).
Prior action #6 The Government of Dadukou District has issued a regulation which sets forth a clear division between government and commercial activities, incomes, expenses, assets, and liabilities of its two urban development investment corporations, namely Dasheng and Jianqiao.
4.2.1 Pillar 1: Fiscal Sustainability
52. This pillar corresponds to a fundamental goal of the operation: putting in place institutions that allow Dadukou to assess its expected financial position under various scenarios and to impose ceilings on the comprehensive financing gap (including all outlays for the public investment program) aimed at achieving fiscal sustainability.
53. The first step, facilitated by the World Bank team, develops a tailored debt sustainability framework that allows for a comprehensive evaluation of Dadukou Government’s fiscal strategy from the point of view of fiscal sustainability. This exercise takes into full consideration current fiscal arrangements in Chinese district‐level governments. A complicating factor for developing this framework is the fact that UDICs still play a major role in carrying out local public investment programs. District UDIC commercial liabilities thus continue to be tightly intertwined, at least in the short term, with the UDICs’ public investment functions. An expanded expected role for PPPs in the future also implies the need for the prudent management of associated contingent liabilities. In this context, it was agreed that Dadukou would adopt an approach to fiscal sustainability analysis that incorporates public liabilities in the District that are related to public investment, including those of UDICs and PPPs. Following the complete transformation of the UDICs into commercial SOEs, a clearer identification of those debts that imply contingent liabilities for the Dadukou Government will be possible. For now, Dadukou’s fiscal sustainability analysis adopts a very prudent inclusive rather than exclusive approach. While the Budget Reform encourages all subnational governments to develop a medium term budgetary framework, there is still no mandatory timeline for implementation. Furthermore, it is anticipated that most subnational governments will only prepare such a framework for the explicit budget in the absence of a DSA, and leave out contingent liabilities related to public investment. Thus, Dadukou District is a true pioneer.
54. Two prior actions reflect Dadukou’s considerable efforts to place district finances on a fiscally sustainable path.
Prior Action #1: The Government of Dadukou District has adopted and published a medium‐term fiscal strategy, grounded in a debt sustainability analysis, which sets a target for district‐level public investment financing that is consistent with debt sustainability. (May 25, 2016)
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Evidence: Dadukou District Government approved the Medium‐term Fiscal and Public Investment Strategy on May 25, 2016 and authorized the district Finance Bureau to publish the report.(DadukouFu, No.29/2016). The report is published on government website http://www.ddk.gov.cn/upfiles/201605/20160526154736866.pdf .
55. The Medium‐Term Fiscal Strategy Report is built on the agreed fiscal / debt sustainability framework and embodies the fiscal adjustment plan agreed with Chongqing Municipality and the World Bank team. Fiscal sustainability here is defined as satisfying the criteria described in the presentation of Dadukou’s debt sustainability above, namely that the public liabilities in the district as a share of GDP decline or stabilize under a baseline scenario that reflects current official macroeconomic projections, and also stabilize under a stress test under which GDP growth is 2 percentage points slower and land revenues are 20 percent lower. As indicated above, to reach this objective, Dadukou District has frozen the overall volume of outlays on public investment to an annual limit of RMB 1.1 billion over the next five years.
Prior Action #2: The Government of Dadukou District has submitted to Dadukou District People’s Congress an annual budget for 2016 that corresponds to a Medium‐Term Fiscal Strategy plan which is consistent with debt sustainability. (January 28, 2016)
Evidence: Letter signed by Standing Committee of District People’s Congress certifying the receipt from Dadukou District Finance Bureau of an Annual Budget Report for 2016 with an Addendum, and a copy of the Annual Budget Report for 2016 and Addendum that sets the appropriate ceiling for district government sponsored public investment in 2016 .
56. The 2016 budget properly represents the first year of the MTFS. China’s existing regulations require Dadukou District to focus only on direct government debt in the main text of the annual budget document. Dadukou therefore is adding an addendum to the 2016 budget which provides a description of government debt, other public liabilities, debt amortization, public investment financing, and an outline of the fiscal adjustment plan. This outline of the fiscal adjustment plan includes the agreement with Chongqing Municipal Government on an adjustment in the sharing rules for revenues from land leases in Dadukou by the municipal UDICs. The Municipal Finance Bureau has issued related circulars.
57. Pillar 1 uses a single comprehensive results indicator: the size of the actual annual financing gap (including all the outlays for the public investment program). This measure will verify if Dadukou’s finances are on track for implementation of the Medium Term Fiscal Plan. Dadukou will reduce this gap from 8.1 percent of GDP in 2015 to less than 3.5 percent in 2016.
4.2.2 Pillar 2: Integrated Capital Investment Plan
58. While most developing and emerging market economies struggle to generate adequate levels of investment in infrastructure, China has maintained investment/savings rates of over 40 percent of GDP, fueling an unprecedented pace of infrastructure construction. Much of this infrastructure investment was carried out at the level of local government. However, growing stocks of unsold housing and other under‐utilized new infrastructure, together with a rapidly rising incremental capital‐output ratio suggest that marginal returns in public investment are declining in many provinces. At the same time, the financing of this investment led to the rapid accumulation of local government debt. Current priorities for economic rebalancing in China seek to increase the share of consumption relative to investment, induce more prudent fiscal management by local governments, and improve the efficiency of public investment.
59. For investment budgeting, the Dadukou government has made significant recent progress in improving project management, particularly with respect to major projects. A project pipeline for 25 infrastructure development is established as part of the District Five Year Plan. All public investment projects above a threshold of 10 million RMB are subject to comprehensive feasibility studies according to the guidelines of the National Development and Reform Commission (NDRC). Procurement for larger projects involves a competitive process with the supervision by the Department of Finance. A designated office monitors the progress of major projects and coordinates with other departments to facilitate implementation. Overall, Dadukou has performed well in areas of project design, appraisal, cost control and progress of implementation.
60. The efficiency and sustainability of public investment in local governments in China typically suffers from fragmentation in planning and implementation. The budget is managed by the Finance Bureau, while investment planning is carried out primarily by the District Development and Reform Commission (DRC). Project‐by‐project plans have their own financing schemes that are often disjoint from the budget. This can be associated with weak overall control over public investment spending and limitations for the cost‐benefit prioritization of projects. The reforms in Dadukou now necessitate a more integrated approach to capital budget planning under the overall ceiling prescribed by prior action #1. Under this approach, the District DRC and the Finance Bureau are cooperating closely on a capital investment plan that optimizes returns from public investment outlays that are now limited by the imposed ceilings.
Prior Action #3: The Government of Dadukou District has issued a three‐year rolling capital investment plan that is consistent with the ceilings on public investment outlays in the Medium‐Term Fiscal Strategy for public investment projects during 2016, and for commitments made in 2016 for public investment outlays in the years 2017‐2018. (April 26, 2016)
Evidence: Decree DuFaGaifa [2016] No.73 from Dadukou District Development and Reform Committee dated April 26, 2016.
61. Dadukou prepared a 3‐Year Rolling Capital Investment Plan (CIP) that seeks to ensure that existing commitments are realized, viable projects are completed, and that all new projects are in line with fiscal sustainability. The Medium Term Fiscal Strategy sets the annual commitments and new exposures stemming from planned capital projects. In formulating the three‐year rolling capital investment plan, Dadukou District provided priority to the on‐going projects first, and selected new projects from the pipeline based on the rank of their readiness for implementation and relevance to the district development strategy. The readiness for implementation is judged on the basis of project ex ante evaluation, technical design and feasibility studies. The District Government carried out wide consultations with stakeholders, citizens and District People’s Congress representatives before finalizing the CIP. The CIP encompasses all public projects that require explicit financial commitments from the District at any given present or future date. The CIP in 2016 encompasses 26 projects. 35.2 percent of planned financing is devoted to already on‐going projects. Half of the new projects have duration of longer than one year. The CIP gives a comprehensive review of all future explicit and implicit obligations by the local government associated with investment projects, and gives particular scrutiny to new projects in annual budgets going forward.
62. There are already plans to modify the CIP preparation process based on the learning experience of 2016. In 2016, the CIP planning process properly identified high priority projects for inclusion in the CIP, but also included what turned out to be an excessive number of lower priority projects. Consequently, a significant adjustment was made at midyear to allocate a larger share of resources under the aggregate ceiling to higher priority areas and not fund a good number of other projects included in the CIP. With the experience of 2016 to build on and more time for the preparation of the next integrated
26 rolling 3‐year capital investment plan for 2017, Dadukou plans to do a better ex ante identification of projects for the allocation of funding.
63. The program strengthens Dadukou’s existing regulations concerning the Examination and Approval System for capital projects with an eye toward promoting fiscal sustainability. The Finance Bureau is ensuring that aggregate financing for newly approved projects in the annual budget, together with net financing needs to complete on‐going projects, are in line with the MTFS‐DSA annual spending and debt targets. The process also incorporates provisions for contingent liabilities, thus supporting a more systematic review by the Finance Bureau of the future financial implications of new capital project commitments.
64. With the adoption of this first integrated investment plan, Dadukou District places ceilings on the entire public investment program, on and off‐budget. The ceilings on commitments for 2017‐2018 are also pertinent, given the fact that local government contributions to investment projects often take the form of pledges of outlays for future years. This allows Dadukou to give fuller consideration of fiscal constraints and sustainability in public investment planning.
Prior Action #4: The Government of Dadukou District has issued a decree that specifies the time frame and division of institutional responsibilities for the annual formulation of a three year rolling capital investment plan, beginning in 2016. (April 29, 2016)
Evidence: Decree DadukouFuFa [2016] No.6 from Dadukou District Government dated April 29, 2016
65. Under prior action #4, Dadukou District institutionalized the annual preparation of the 3‐year rolling capital investment plan. This should solidify the strong cooperation between the District DRC and the Finance Bureau on public investment planning and finance, and provide a framework for assessing and re‐assessing comprehensive commitments to public investment for a three year period going forward. This plan should also continue to be linked closely to the Medium Term Fiscal Strategy and debt sustainability.
66. Results indicators for Pillar 2 will focus on the credibility of the capital investment plan in Dadukou. One indicator measures the degree to which Dadukou realizes its goal of limiting executed outlays on investment projects in 2016 to be less than the ceilings imposed by the capital investment plan and corresponding to the MTFS. A second results indicator measures the variance of actual capital investment with the capital investment plan (aggregating the individual outcomes of all projects). A list of all projects compiled by Dadukou District DRC in 2015 is used to generate a baseline for these two indicators. The list provides the number of approved projects, financial outcomes from projects implemented, and the number of projects dropped. In Dadukou, only 28 out of 44 capital investment projects in the list were implemented in 2015. It is expected that the new institution of an integrated capital investment plan will improve the credibility of project budgeting. As it takes time to build the needed institutional capacity to implement the investment projects strictly as planned, the results indicator is chosen for the 2017 budget.
4.2.3 Pillar 3: Transparency
67. China’s de facto very high degree of fiscal decentralization finds reflection in a significant degree of informational decentralization. While local governments in China are responsible for the majority of budgetary expenditures, public investments, and debt accumulation, the information available to the public and higher levels of government remains limited. Under the budget reform, Chinese provinces are instructed to improve their monitoring of the financial health of local governments. The provincial‐level 27 early warning system for local governments is being built on 7 indicators from information that is observable at the provincial level, including the size of (explicit) debt stock and debt servicing relative to expenditures and assets. These indicators provide valuable information, but still do not account for all sources of fiscal risk at the local level. Limited information exists at the provincial level on local governments for public investments not reflected in the budget and their associated contingent liabilities, the projected economic situation in the locality, and other measures of the capacity of local governments to shoulder debt. The regular preparation of a Medium‐Term Fiscal Strategy linked to a DSA, corresponding to prior action #1, should provide additional valuable information in this regard for the Chongqing Municipality. So should the capital investment plan that will include a comprehensive project‐ by‐project itemization for the current budget year.
Prior Action #5: The Government of Dadukou District has adopted a decree for regular annual disclosure of the assets and liabilities of the public sector, including public benefit state‐owned enterprises. (April 27, 2016)
Evidence: Decree DuCaiFa [2016] No.54 from Dadukou District Finance Bureau dated April 27, 2016.
68. Under prior action #5, Dadukou solidified its leading position among local governments in China by issuing a decree requiring the regular annual disclosure of the assets and liabilities of the public sector including public benefit SOEs in addition to the requirements of the Central Ministry of Finance. This will give the public both more frequent and more complete access to relevant information on the District’s finances beyond what is currently required by the Central Government. Current regulations only require that a far less comprehensive report be prepared, and there is no requirement for disclosure.
69. A major goal of the Budget Reform is to convert local government financing vehicles into strictly commercial state‐owned enterprises, thereby providing a clear divide between government and UDIC accounts. While this is a general goal, progress across China has so far been mixed. The inventory of local government debt taken in 2014 made an important distinction between government and commercial debt in UDICs, making the former an explicit responsibility of local governments. As part of the DPF Program, Dadukou District is taking a major step toward the separation of UDICs from government by dividing the assets and liabilities of each of its two UDICs into government and commercial components. Assets that don’t generate revenues or commercial interest and liabilities emanating from financing public investments that have received verification by the Government Audit Office are brought explicitly on the government’s account. Starting from 2016, the financing of public investments by UDICs will either be carried out explicitly on a commission basis or will be recorded entirely on the government’s account. In this endeavor, the commercial sides of the UDICs thus created will be genuine commercially viable entities. Dadukou District will be an important pioneer in this regard.
Prior Action #6: The Government of Dadukou District has issued a regulation which sets forth a clear division between government and commercial activities, incomes, expenses, assets, and liabilities of its two urban development investment corporations, namely Dasheng and Jinqiao. (April 17, 2016)
Evidence: Decree DuGuoZiWei [2016] No. 8 from Dadukou District State‐owned Assets Supervision and Administration Commission dated April 17, 2016.
70. Under prior action #6, the Dadukou Government determined a clear division between government and commercial activities, incomes, expenses, assets, and liabilities in the two UDICs: Dasheng and Jianqiao. Dadukou State‐owned Assets Supervision and Administration Office issued a Decree to instruct Dasheng and Jianqiao to carry out such a division. An independent accounting firm will verify the compliance of the operation with the Circular. The service of the accounting firm will be 28 procured by a competitive bidding process. This will be a first step toward the spin‐off of the commercial UDICs as truly independent entities and opening them for outside investors. While the time frame of this operation can only cover the beginning of this process, it is expected that this will incentivize the government to finance public investment on budget, and the UDICs can already begin working according to explicit commissioned contracts with Dadukou District. Thus, the results indicator will measure the share of public projects with the participation of Dasheng or Jianqiao based on explicit commissioned contracts.
71. A results indicator for prior action #5 is that Dadukou compiles and publishes in the public domain (District Government official website) a report on the assets and liabilities of the public sector for the year 2015 by end‐August, 2016. Given the fact that the two local UDICs hold most of the district government assets and liabilities, Dadukou consolidates the assets and liabilities of the two UDICs in the public sector. This goes beyond the requirement of Chinese MOF and provides more comprehensive information about the district’s finances.
72. Given the accounting split in the UDICs that creates a separation of government and commercial books, activities related to public investment booked as commercial will be based on an explicit commissioned contract. This will be an important institutional change in how the UDICs function in practice. Correspondingly, it is expected that the share of investment projects carried out by UDICs on an explicit commissioned basis would increase. Therefore, this is the results indicator that corresponds to prior action #6.
4.3 LINK TO CPS, OTHER BANK OPERATIONS AND THE WBG STRATEGY
73. This operation is fully aligned with the Country Partnership Strategy’s (FY2013‐FY2016) theme 2: promoting more inclusive development. In particular, the CPS (Report No. 67566‐CN) notes the importance going forward for “integrating policies and program administration” for China’s future developmental success. The China Performance and Learning Review (Report No. 95709‐CN) of January, 2016 noted that future IBRD lending in China may include PforR and DPO instruments. The operation also corresponds to the objective in the CPS for deepening direct cooperation at the subnational level. Given the increase in subnational borrowing recorded in recent years and the 2014 reform of the budget law, there is now significant need and interest for a systematic reform of subnational budgeting practices. This operation will be a pilot that can act as possible blueprint for the eventual roll‐out of subnational fiscal reform across districts in the whole of China. By thereby promoting modern and best‐practice debt management systems at local governments, this operation contributes to safeguarding sustainable growth in China, and hence to achieving the twin goals of ending extreme poverty and promoting shared prosperity. The operation also supports the Chinese government’s overarching objective to establish a comprehensive, transparent and efficient fiscal system by 2020.
74. This subnational fiscal reform DPF in Chongqing‐Dadukou District (P157404) is complemented by a subnational fiscal reform DPF in Hunan Province (P157406). Together, these pilot projects aim to bring best practice debt management frameworks to both provincial and sub‐provincial governments in China.
75. These DPFs also complement a fiscal technical assistance operation at the national level (P154694), which includes the following activities:
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Facilitate formulation, design and implementation of policies, institutional modifications required to support a modern fiscal system in China with due consideration to changing economic structures domestically and internationally; and
Develop a pool of skilled management talent and broaden international knowledge exchange and dialogue on fiscal issues based on generally accepted international rules to facilitate reform implementation.
76. Chinese authorities have indicated that the capacity building component of the Fiscal Technical Assistance Operation should be used for training subnational officials as well as cadres of the Central Government. This suggests natural synergies with scaling up subnational reforms informed by the DPF pilots.
77. The World Bank is coordinating analytical work around subnational finance and intergovernmental relations. This includes the Fiscal Policy Analysis Program (P158478) and the Institutions for Public Sector Performance Program (P157831), which will be closely coordinated with this DPF and the operation in Hunan Province. It will feed into a continued engagement at the subnational level, including policy advice and technical assistance.
4.4 CONSULTATIONS, COLLABORATION WITH DEVELOPMENT PARTNERS
78. This operation contributes to the achievement of the Government’s overarching fiscal objectives set at annual plenary sessions of the Chinese People’s Congress after broad consultation with stakeholders. Specifically, this project supports the government’s implementation of the fiscal reforms. Dadukou District Government has engaged in broad consultations with the District People’s Congress, Chongqing Municipal Government, and Central Government (MOF and NDRC) on the program for this operation.
79. Various other development partners are supporting China’s fiscal reforms. These include the IMF, which supports fiscal reform through its regular Article IV monitoring missions and technical assistance. The Asian Development Bank is also running related technical assistance operations on fiscal reforms and development policy financing in China. The Organization for Economic Cooperation and Development (OECD) has prepared various analytical reports. This operation of the World Bank complements these initiatives through a fiscal reform lending operation at the subnational level.
80. Consultations have been held with the IMF. The IMF has a strong interest in fiscal sustainability issues at the subnational level in China, and is fully supportive of this direction of World Bank engagement in China. The IMF is providing technical assistance to the Central Government (MOF) on formulating medium‐term fiscal plans, reconciling the cash‐based budget classification with an accrual‐based chart of accounts, and improving cash management. It is envisioned that close cooperation with the IMF on budget reforms will continue following this operation. IMF Article IV Consultation Mission Statement is attached. (Annex 4)
5. OTHER DESIGN AND APPRAISAL ISSUES
5.1 POVERTY AND SOCIAL IMPACT
81. Chongqing‐Dadukou is undergoing a significant fiscal consolidation effort, although negative welfare effects from this operation are not expected. The local economy suffered from the closure of an
30 important steel plant in 2012. Public debt has now reached high levels and economic activity has been supported by unsustainable public investment growth. Going forward, the District will need to severely constrain further growth of public expenditure. Although Chongqing‐Dadukou aims to attract more private investment to support economic growth under the tighter fiscal stance, the nature of Chongqing‐ Dadukou’s current overall economic and fiscal situation implies some risks for local progress on poverty and social indicators. Nevertheless, the operation is not expected to have a negative impact on the welfare of the local population due to the fact that social spending should not be affected. Chongqing currently has a vibrant labor market, and the unsustainability of the District’s finances necessitated a fiscal adjustment even in the absence of this operation. The operation is helping Dadukou make this adjustment in an orderly fashion to increase the probability of stability and preserve programs of the highest developmental priority.
82. The prior actions for this operation set in place a best‐practice budgetary system to (i) minimize the short‐term social cost of this fiscal consolidation effort and (ii) to maximize the probability that the adjustment plan will lead to sustainable local public finances and growth. The prior actions and triggers aim to support a budget planning framework that takes a holistic and forward‐looking perspective. Three‐ year budgeting, subject to debt sustainability analysis, means that the full consequences of individual fiscal consolidation measures are taken into account when designing the adjustment program, including the impact of policies on future growth and living conditions. A credible upfront medium‐term adjustment plan also reduces current policy uncertainty, potentially helping to attract new private investors to the District. A capital budgeting framework ensures that fiscal risks from the entire Chongqing‐Dadukou investment plan are evaluated, including contingent liabilities from projects that are not currently consolidated in the official Chongqing‐Dadukou budget.
83. The potential negative social impact from expenditure compression in Dadukou District is mitigated by a number of factors. Firstly, the proposed fiscal consolidation does not target expenditures on budget, a large portion of which are determined by central regulations and norms. Thus, current social spending should not suffer. The fiscal adjustment concerns public investment. Second, the introduction of the integrated investment plan will help prioritize capital outlays for maximal development impact in line with priorities of Dadukou that emphasize social infrastructure. Third, the small size of Dadukou and its place in the heart of Chongqing Municipality disciplines the District into supplying comparable services to other parts of the city. The most direct welfare impact from the fiscal consolidation might be slower renovation or replacement of social infrastructure. However, this consolidation would have been inevitable even without this operation, as growth in investment spending was on an unsustainable path.
84. More moderate levels of public investment in Dadukou District should have little impact on employment. As Dadukou is only a district of 300,000 people in the large Chongqing Municipality with a population of 30 million, the creation of somewhat fewer jobs in Dadukou public investment projects should have a very small impact on the employment situation for residents of Dadukou or other parts of Chongqing. As one of the most rapidly growing regions in China, Chongqing has experienced steady employment growth in recent years. In 2015, Chongqing’s registered unemployment rate was 3.5 percent, less than that national 4 percent rate. Within Dadukou, registered unemployment is under 2 percent.
5.2 ENVIRONMENTAL ASPECTS
85. The proposed DPF will not entail direct environmental impacts as its main focus is essentially to enhance budget management of the Government. The prior actions do not have discernable implications for the environment. In general, the Dadukou District Government has given a high priority to the
31 environment and targets green growth. The debt distress addressed by this operation is due in part to the relocation of a polluting steel factory out of Dadukou in 2011 for environmental reasons. In addition, all projects selected in Dadukou CIP are required to meet national environmental standards. Project sponsoring entities carry out the environment evaluation under the supervision of Department of Environment Protection in line with national guidelines, the District DRC recruits independent consulting firms to review and verify environment evaluation results before authorizing the implementation of investment projects. Dadukou’s policy framework, institutions, and capacity to monitor and manage environment effects are viewed adequate.
5.3 PFM, DISBURSEMENT, AND AUDITING
PFM AND DISBURSEMENT
86. Important progress has been made in recent years in both the national public financial management (PFM) regulatory environment and the way that Dadukou District’s public finances are managed. PFM laws and regulations are established at the national level in key areas such as budget, debt, financial reporting, audit and others. Provincial, municipal and lower levels of government adhere to this PFM regulation but have some autonomy in determining how national regulation is implemented at the local level and in establishing other complementary and more detailed PFM regulations. In recent years, national PFM law and regulations have been strengthened. Notably, the 2014 Budget Law established significantly better control over subnational debt. MOF is also leading a national transition to accrual accounting. MOF and Chongqing Municipality financial information systems have also been made available to Dadukou. Both measures support and have strengthened the District’s PFM.
87. Dadukou’s PFM environment is sound and PFM reforms are modernizing the District’s governance. Budget preparation is orderly, budgets are disclosed on a timely basis, fiscal transparency has improved by disclosing two additional levels of budget detail and budget reliability has improved (2015 revenue variance was less than 1 percent). Dadukou has taken significant steps in strengthening the quality of its PFM systems in other areas: moving onto Chongqing Municipality’s integrated FMIS platform with centralized disbursement in 2013, and moving from manual to automated payroll processing in late 2013. The FM review of Dadukou’s PFM systems (no national or subnational Public Expenditure and Financial Accountability (PEFA) reviews have been carried out in China) noted that these ongoing reforms are addressing important Dadukou’s PFM development needs. Opportunities for further improvements exist in areas such as debt management, capital investment and the quality and comprehensiveness of fiscal disclosures.
88. The People’s Republic of China has four well established and nationally used procurement laws and regulations: (i) Tendering and Bidding Law of January 1, 2000; (ii) Government Procurement Law of January 1, 2003; (iii) Implementation Regulation on Tendering and Bidding Law of February 2012; and (iv) Implementation Regulation on Government Procurement Law of March 2015. The Tendering and Bidding Regulations in Chongqing became effective on January 1, 2009. The invitation for bids and contracts award are disclosed through websites such as http://www.ccgp.gov.cn, and http://www.cpcb.com.cn. Procurement is subject to supervision by various government authorities such as audit offices, DRC, and the financial bureaus (FB) at different levels.
89. The Bank has reasonable assurance that the control environment for foreign exchange in the People’s Bank of China (PBOC) is satisfactory for the purposes of this operation. China’s foreign exchange reserves reported by PBOC were USD3.22 trillion in April 2016. The International Monetary Fund (IMF) has not carried out a safeguards assessment of the PBOC. However, the IMF’s November 2015
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Policy Paper on valuation of the SDR noted that Chinese authorities have made notable strides in enhancing data disclosures that include China’s reserves. The PBOC is audited by the China National Audit Office (CNAO), China’s supreme audit institution. CNAO’s audit of PBOC is largely compliance in nature and it therefore does not issue an audit opinion on PBOC’s financial statements. PBOC’s 2014 Annual Report stated: It maintained its diversified investment strategy, optimized the allocation of currencies and assets, and ensured the safety, liquidity, maintenance and appreciation of the value of the foreign exchange reserve. It further improved the risk management framework, intensified the early warning and judgment of risks, perfected the contingency plan and enhanced its capacity of withstanding the impact of crises.
90. The overall fiduciary risk to this operation arising from Dadukou’s PFM system, the use of budget resources and its foreign exchange environment as controlled by the Central Bank is assessed to be moderate.
Disbursement Arrangements
91. The Borrower is the People’s Republic of China. This operation is an IBRD loan of US$ 200 million. It is a stand‐alone single‐tranche DPF operation. The World Bank loan agreement will be signed between the World Bank and MOF, the on‐lending agreement will be signed between MOF and Chongqing Municipality Finance Bureau (CMFB) on behalf of Chongqing Municipal Government, then in turn between CMFB and Dadukou Finance Bureau on behalf of Dadukou District Government. The on‐lending currency is in US dollar and the terms are the same as stipulated in the loan agreement between the World Bank and MOF. Dadukou Finance Bureau will be responsible for repaying the World Bank loan on behalf of Dadukou district government. Given the Dadukou Finance Bureau is the ultimate borrower and user of the Bank loan proceeds, Dadukou Finance Bureau will take the foreign exchange risk.
92. The proposed Bank loan will follow the Bank’s disbursement procedures for development policy lending. The loan will be disbursed once evidence of fulfillment with prior actions has been accepted and an adequate macroeconomic framework has been maintained. Upon the withdrawal application submitted by the Borrower, the Bank would disburse the loan proceeds, denominated in US dollars, into a designated foreign currency account held by CMFB in a commercial bank acceptable to the Bank. Then the USD loan proceeds will be immediately converted into equivalent Renminbi and transferred into the treasury single account (TSA) of CMFB in the Central Bank. Finally, CMFB will transfer exactly the same Renminbi amount from its TSA to the TSA of Dadukou Finance Bureau in the Central Bank which would become available to Dadukou District Government to finance budgeted expenditures.
93. Within 30 days after the Bank loan disbursement, the Borrower (or MOF via CMFB) will accordingly provide the Bank with a written confirmation of the USD amount received, the amount of RMB transferred to the TSA to finance budgeted expenditures, and the exchange rate used for converting USD into RMB.
5.4 MONITORING AND EVALUATION
94. The development policy financing, including the program objectives, prior actions, and results indicators, has been prepared through intensive policy dialogue with the Government. The main counterparts are the Finance Bureaus of Chongqing‐Dadukou District and Chongqing Municipality as well as the DRC of Chongqing‐Dadukou District and Chongqing Municipality. The projects are also supported and coordinated by the national Ministry of Finance and the NDRC.
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95. The Dadukou District Finance Bureau will have the main responsibility of the day‐to‐day monitoring on implementation and progress in the DPF program. Other government bodies, including the District DRC, will contribute to this process in line with their corresponding functional responsibilities in the DPF program. In all cases, the results indicators are already being tracked by the associated institutions. The operation builds on the existing monitoring and evaluation systems of the Government, which should ensure that program performance is monitored at minimal cost to the respective institutions.
96. Dadukou District is building further capacity for effective monitoring. The monitoring of some of the results indicators will require some effort from Dadukou in compiling adequate information. The first results indicator requires accurate measures going forward of the District financing gap. While this was not monitored by Dadukou in the past, the new approach to integrated capital budgeting and debt sustainability analysis will provide the information needed to properly consolidate revenues and expenditures to monitor this measure. Dadukou will continue to build capacity for this purpose. Monitoring the second measure may also require some effort, as not all investment expenditures are subject to cash controls of the Government budgets. The UDICS must limit their off‐budget borrowing and investment outlays to reach the targets. In the past, UDICs sometimes accelerated the implementation of multi‐year projects in a manner that would be inconsistent with the annual ceilings that are now being enforced. Dadukou District is aware of this challenge, and will monitor the UDICs closely from this point of view.
97. Grievance Redress. Communities and individuals who believe that they are adversely affected by specific country policies supported as prior actions or tranche release conditions under a World Bank Development Policy Operation may submit complaints to the responsible country authorities, appropriate local/national grievance redress mechanisms, or the World Bank’s Grievance Redress Service (GRS). The GRS ensures that complaints received are promptly reviewed in order to address pertinent concerns. Affected communities and individuals may submit their complaint to the World Bank’s independent Inspection Panel which determines whether harm occurred, or could occur, as a result of World Bank non‐ compliance with its policies and procedures. Complaints may be submitted at any time after concerns have been brought directly to the World Bank's attention, and Bank Management has been given an opportunity to respond. For information on how to submit complaints to the World Bank’s corporate Grievance Redress Service (GRS), please visit http://www.worldbank.org/GRS. For information on how to submit complaints to the World Bank Inspection Panel, please visit www.inspectionpanel.org. ”
6. SUMMARY OF RISKS AND MITIGATION
98. The overall risk rating for this subnational operation is substantial. The main risks include (i) limited implementation capacity at the District level, (ii) required close cooperation between government departments at the District, municipal‐provincial and national level, (iii) further substantial adjustments to the national budget framework, and (iv) macroeconomic uncertainty. Materialization of any of these risks could imperil the District’s ability and willingness to implement the modern and best‐practice debt management framework supported by this operation. Beyond passage of the appropriate decrees and circulars, the success of the budgetary reforms envisaged by this operation requires the new framework to become ingrained over several budget cycles.
99. Implementation capacity: Limited implementation capacity at the subnational level represents a primary risk faced by this operation. The budgetary reforms envisaged are ambitious at any level of government in China, but particularly at the local level. Carrying the full debt sustainability analysis forward beyond the scope of this operation requires skills and time. While some officials in Dadukou have
34 developed these skills, there is always the risk that they may not be passed on effectively in the event that responsibilities within the administration are reassigned or some cadres leave for other work. It will take time to institutionalize effectively within Dadukou the procedures and analytical capabilities associated with maintaining the program. The determination of Dadukou to succeed in this endeavor is one source of risk mitigation. The Bank will also remain engaged with Dadukou on the implementation of reforms.
100. Cooperation between departments across levels of government: Setting up and operating the new debt management and capital investment system requires close cooperation and the support of multiple departments, particularly the Finance Bureau in charge for the budget and the District DRC in charge of the investment plan and setting economic development targets. It also requires support from these Departments’ counterparts at the level of the Chongqing Municipality and at the level of the national government. To enhance needed collaboration under the DPF program, the Government of Dadukou District has issued a decree that specifies a division of institutional responsibilities for the annual formulation of a three year rolling capital investment plan, and establishes a collaboration mechanism among all stakeholders under the coordination of the Executive Committee of the District Government.
101. Further changes to the national fiscal framework: the 2014 reform of the national budget law has been adjusted in a series of subsequent State Council decisions, and further adjustments are expected. Budgetary reforms at the District level may therefore need to be recalibrated in line with upstream changes. This could require revisions to the Dadukou Government’s program supported by this DPF. The overall spirit of the Budget Reform continues to be supported at the national level, however, and changes will most likely correspond only to the roadmap for implementation.
102. Macroeconomic risks: a sudden deterioration of the economic environment can imperil the achievement of the result indicators set for this operation. Budgetary pressures may also undermine, or at least delay, implementation of the institutional reforms supported by the program, particularly if local administrators see the need for greater short‐term budgetary flexibility. While the fiscal program of Dadukou District appears sustainable under a range of macroeconomic assumptions that include slower‐ than‐expected growth and lower land revenues, a much sharper downturn would overturn sustainability and require further adjustments and / or support.
Table 6: Summary Risk Ratings Risk Categories Rating (H, S, M or L) 1. Political and governance S 2. Macroeconomic S 3. Sector strategies and policies M 4. Technical design of project or program M 5. Institutional capacity for implementation and sustainability S 6. Fiduciary M 7. Environment and social L 8. Stakeholders M 9. Other n/a Overall S
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ANNEX 1: CHONGQING‐DADUKOU DISTRICT FISCAL SUSTAINABILITY DPF ‐ POLICY AND RESULT MATRIX
Prior Actions Results Indicators (Baseline and Target) Pillar 1 – Fiscal Sustainability Objective A: Developing and employing a medium term fiscal / debt sustainability framework for managing risks and ensuring the fiscal sustainability of Dadukou’s public finance Prior action #1: The Government of Dadukou District has adopted A1: Dadukou District financing gap as and published a medium‐term fiscal strategy, grounded in a debt a share of District GDP sustainability analysis, which sets a target for district‐level public Baseline: 8.1% (2015) investment financing that is consistent with debt sustainability. Target: < 3.5% (2016)
Prior action #2: The Government of Dadukou District has submitted to Dadukou District People’s Congress an annual budget for 2016 that corresponds to a Medium‐Term Fiscal Strategy plan which is consistent with debt sustainability.
Pillar 2 ‐ Integrated Capital Investment Plan Objective B: Developing an integrated approach to capital investment plan to improve efficiency Prior action #3: The Government of Dadukou District has issued a B1: Dadukou executed outlays on three‐year rolling capital investment plan that is consistent with investment projects in 2016 the ceilings on public investment outlays in the Medium‐Term Baseline: 1.79 billion RMB (2015) Fiscal Strategy for public investment projects during 2016, and for Target: < 1.1 billion RMB (2016) commitments made in 2016 for public investment outlays in the years 2017‐2018.
Prior action #4: The Government of Dadukou District has issued a B2: Variance of executed investment decree that specifies the time frame and division of institutional in Dadukou District with capital responsibilities for the annual formulation of a three year rolling investment plan. capital investment plan, beginning in 2016. Baseline: 0.514 (2015) Target: < 0.4 (2017) Pillar 3 ‐ Transparency Objective C: Enhancing transparency and accountability in the use of budget resources Prior action #5 The Government of Dadukou District has adopted C1: Annual report on public sector a decree for regular annual disclosure of the assets and liabilities assets and liabilities on official website of the public sector, including public benefit state owned Baseline: No (2015) enterprises. Target: Yes (2016) C2: Share of projects executed by Prior action #6 The Government of Dadukou District has issued a Jianqiao and Dasheng that regulation which sets forth a clear division between government correspond to explicit commissioned and commercial activities, incomes, expenses, assets, and contracts liabilities of its two urban development investment corporations, Baseline: 9% (2015) namely Dasheng and Jianqiao. Target: >30%(2016)
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ANNEX 2: LETTER OF DEVELOPMENT POLICY FROM DADUKOU DISTRCT GOVERNMENT
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People’ Government of Chongqing‐Dadukou District Letter of Development Policy for Dadukou District Development Policy Financing (DPF) Program
Dear President Kim,
First of all, I would like to extend our warm greetings to you and express our gratitude for the World Bank’s support of the Chongqing‐Dadukou District Development Policy Financing (DPF) program. This DPF provided the District Government with general budget support, promoted the District’s fiscal reform and achieved related development goals.
China’s new Budget Law, which took effect on Jan. 1, 2015, envisions a comprehensive, rule‐based, open and transparent budget regime. The Law has created new and higher standards for fiscal management by subnational government – in particular, it clearly stipulates that subnational governments should borrow on budget and within the ceiling. The State Council issued its Opinions on Implementing Medium Term Fiscal Planning (State Council [2015] No.3) on Jan. 23, 2015, which requires subnational governments to develop medium term fiscal plans to strengthen budgetary discipline and achieve fiscal sustainability.
In this context, with the approval of both the State Council and the World Bank, Dadukou District is now taking the lead in integrating its fiscal reform program with a World Bank DPF. The hope is to create a public finance regime that includes a medium term fiscal framework, public investment budgeting, and regular publication of public sector asset and liability reports. Such a regime will lay a solid foundation for further fiscal reforms in the future.
Based on the above consideration, as Chief of the People’s Government of Chongqing‐Dadukou District (legally designated representative of the District Government), I hereby apply to the World Bank for a single‐tranche development policy financing in the equivalent of US$ 200 million and make the following solemn commitment: Dadukou District will, with help from the World Bank and supported by this DPF and related reform measures, develop a forward‐looking, comprehensive, and transparent public finance framework that integrates budget, public investment, and debt management, thus improving the efficiency of public investment (especially the efficiency of infrastructure investment), and strengthening debt management, and eventually achieving medium‐ and long‐term fiscal sustainability. Below I will elaborate on the rationale for this DPF application and progress in our prior actions.
I. Background
Dadukou District is one of the nine urban districts of Chongqing Municipality, with 330,000 residents and GDP of RMB 15.97 billion. During the 12th Five Year Plan (FYP) period, the District was faced with multiple challenges, including a macroeconomic downturn, relocation of the Chongqing Iron and Steel Company and resulting pressure to transform its economy as well as upgrade its industries. Due to the relocation of the Chongqing Iron and Steel Company, the District’s economic output declined by 28.3 percent between 2010 and 2012. However, in recent years, with support from both the Central Government and Chongqing Municipal Government, Dadukou District has stepped up its effort to nurture new industries and new
43 drivers of economic growth. The annual growth rate has quickly rebounded to 7.1 percent, 9.1 percent, and 10 percent in 2013, 2014, and 2015, respectively. On the basis of the national economic environment, Dadukou District targets 9 percent annual real GDP growth for the 13th FYP period.
The District Government spent a total of RMB 10.11 billion on public investment during the 12th FYP period, averaging RMB 2.022 billion per year. This accounted for 13.2 percent of the District’s fixed asset investment (RMB 76.56 billion) over this period. The majority of this investment supported infrastructure and social projects, such as the construction of social housing.
Following the relocation of the steel mill and the resulting local economic downturn, the District’s limited fiscal revenues have been under pressure. At the same time, mandatory expenditure has continued to grow and public investment was not brought under control. As a result, the District has accumulated significant government debt associated with infrastructure projects, the transformation of old neighborhoods, and the construction of an industrial park. By the end of 2015, the direct government debt of Dadukou District stood at RMB 10.54 billion, equivalent to 177.0 percent of its fiscal revenue and 65.9 percent of local GDP. If other debts accumulated by District Local Government Financing Vehicles (LGFVs) in the past are also included, the debt level of Dadukou is even higher. This heavy debt burden poses a great challenge to the District’s fiscal sustainability and might affect its future economic and social development.
It is, therefore, a priority for the District of Dadukou to strive for fiscal sustainability by controlling government investment at a reasonable level. This World Bank DPF not only fits well the general agenda of ongoing fiscal reforms, but also provides the means and technical support for addressing the District’s fiscal sustainability problem.
II. DPF‐related reform measures
The DPL has three pillars: fiscal sustainability, public investment budgeting, and fiscal transparency. These three aspects are complementary with one another: the Medium Term Fiscal Framework aimed at fiscal sustainability is the basis and prerequisite for developing a three‐year rolling Capital Investment Plan, while fiscal transparency can help to ensure the effective implementation of the first two elements. We recognize that fiscal reform and the DPL share the same general objectives – that is, the District Government shall, by adopting a Medium Term Fiscal Strategy, strengthen budget management and improve the efficiency of public investment, which will in turn help promote economic development, improve public services, and benefit Dadukou residents. To this end, we have taken a series of prior actions to push for the actual implementation of fiscal reform measures and this DPF.
A. Fiscal Sustainability
(1) Publishing and implementing a Medium Term Fiscal Strategy. A comprehensive Debt Sustainability Analysis (DSA) concludes that our District should effectively control the size of government investment. To this end, we have developed a practical and feasible Medium Term Fiscal Strategy, which stipulates, among other things, that the District’s annual investment should be restricted at around RMB 1.1 billion in the next five years.
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(2) Submitting to District People’s Congress an annual budget for 2016 that is consistent with the Medium Term Fiscal Strategy. In the 2016 Annual Budget submitted to the Dadukou District People’s Congress, we include an addendum that provides a description of the government debt, the public investment plan, the fiscal adjustment plan, and other related information (not available to the public).
B. Public investment budgeting
(3) Preparing a Three‐Year Rolling Capital Investment Plan (CIP). This plan encompasses all public projects carried out by the District Government. The aggregate investment ceiling is set in line with the Medium Term Fiscal Strategy and the projects are prioritized according to the District’s development plan.
(4) Developing and adopting a decree for the annual preparation of three‐year rolling capital investment plans. We will standardize and institutionalize the practice of preparing such plans by issuing formal government documents. We will also continue to improve the management of government investment by controlling aggregate investment in accordance with fiscal sustainability. We will clearly specify the division of responsibilities for the annual formulation of such plans and strengthen the project management of government investments, so as to achieve greater economic and social impact while ensuring fiscal sustainability.
C. Fiscal transparency
(5) Adopting a decree for the regular publication of public sector asset and liability reports. Following the guidelines issued by the Ministry of Finance, we will prepare the District’s public sector asset and liability reports. These reports reveal detailed government financial information such as assets, liabilities, incomes, and expenses. In order to capture the full picture of Dadukou District’s financial condition, we will go beyond the requirements of the Ministry of Finance by adopting innovative practices: we will consolidate the finances of the two public‐service state‐owned enterprises (SOEs) in the public sector asset and liability report, while recognizing the net worth of commercial SOEs as the investment of government.
(6) Creating separate accounts for the government and commercial activities of the public‐benefit SOEs. This mainly concerns the two UDICs of Dadukou District: Dasheng and Jianqiao. This division is a major step in our effort to advance SOE reforms under the principle of separating government and market domains.
In sum, with the reform measures supported by the DPF, we will build an effective government debt control mechanism and formulate appropriate government investment plans, which will solve the fiscal sustainability problem discussed earlier, enhance fiscal transparency, and promote regional economic development.
Finally, I would like to express our sincere appreciation for the technical and financial support rendered by the World Bank in this DPF. We are confident that this cooperation will have a significant and long‐ lasting positive impact on Dadukou District’s economic development, fiscal reform, and the general welfare of its residents.
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Yours sincerely,
Lu Wei (signature)
Mayor, People’s Government of Dadukou District
April 28, 2016
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ANNEX 3: LETTER OF DEVELOPMENT POLICY FROM CHONGQING MUNICIPAL GOVERNMENT
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13 May 2016
To: Dr. Jim Yong Kim, President The World Bank
Dear President Kim,
Greetings!
On behalf of the Chongqing Municipal Government, I would like to express our gratitude for the World Bank’s support of the Chongqing‐Dadukou District Development Policy Financing (DPF) program.
The Chongqing Municipal Government attaches great importance to this cooperation with the World Bank and hopes that the Dadukou District will, with help from the World Bank and taking this DPF as an opportunity, develop a forward‐looking reform program that integrates budget, public investment, debt management and accountability mechanisms, so as to improve the efficiency of public investment (especially the investment efficiency of infrastructure construction), contain excessive growth of government debt and achieve medium‐ and long‐term fiscal sustainability.
As one of the nine districts of Chongqing City, the Dadukou District is located in the metropolitan area of Chongqing. Due to the relocation of Chongqing Iron and Steel Company, the aggregate GDP of Dadukou District witnessed temporary declines between 2010 and 2012, reducing fiscal revenue accordingly. At the same time, the District has accumulated significant government debts for infrastructure improvements, the renovation of old and dilapidated housing, and the construction of an industrial park. By the end of 2015, the direct government debt balance of Dadukou District totaled RMB 10.54 billion, with both high debt‐to‐revenues ratio (173.5 percent of its fiscal revenue) and high debt‐to‐ GDP ratio (65.9 percent of GDP). Dadukou District is the only district in Chongqing City subject to a warning for high‐debt risk under the Municipality’s Early Warning System.
Both the Budget Law, which took effect on 1 January 2015, and the Opinions on Implementing Management of Medium Term Fiscal Planning promulgated by the State Council in early 2015 put forward higher requirements on subnational debt management. Chongqing City hopes to take the pilot reform program supported by Dadukou District’s DPF as a starting point to explore and establish a scientific and effective permanent mechanism for controlling government debt risks. To this end, Chongqing Municipality applied to the World Bank for development policy financing in the amount of US$ 200 million, which is to support the implementation of fiscal reform piloted in Dadukou District.
Chongqing Municipal Government has always provided rigorous support to the reform efforts of Dadukou District. In 2013, Dadukou District, as the only eligible district/county of Chongqing City, was included into the Plan for Restructuring the Old National Industrial Base (2013–2022). In April 2014, it was selected as a pilot district for national rehabilitation program of old industrial districts. In February 2016,
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Chongqing Municipal Government further clarified the policies on sharing revenues from land‐lease sales by Municipal public‐service SOEs with Dadukou District. These supporting policies have helped Dadukou District make important progress towards transforming its economic and fiscal situation.
We will pay continuous attention to and support the Dadukou District DPF program, and urge the District to complete and implement the various reform measures supported by the DPF, so as to achieve all result indicators. We are confident that with support from the World Bank, the Dadukou District will see significant improvements in fiscal sustainability, public investment efficiency and budget transparency. The sustainable fiscal management mechanism established in Dadukou District will also set an example for other districts/counties of Chongqing City, and provide a model for how other Chinese districts with high fiscal risks can bring their debt levels under control.
Once again, I would like to thank the World Bank for its technical and financial support to this DPF program, and wish the program a great success!
Best regards,
Weng Jieming
(Signature)
Executive Vice Mayor
Chongqing Municipal People’s Government
13 May 2016
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ANNEX 4: IMF ARTICLE IV CONSULTATION MISSION STATEMENT
IMF Press Release No. 16/374
On July 27, 2016, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation 1 with China.
China continues its transition to sustainable growth, with progress on many fronts yet also many challenges. Growth slowed to 6.9 percent in 2015 and is projected to moderate to 6.6 percent this year owing to slower private investment and weak external demand. The economy is advancing on many dimensions of rebalancing, particularly switching from industry to services and from investment to consumption. But other aspects are lagging, such as strengthening SOE and financial governance and containing rapid credit growth.
Inflation dipped below 1.5 percent in 2015 and is expected to pick up to around 2 percent this year, reflecting the rebound in commodity prices and the exchange rate depreciation since mid‐2015.
Infrastructure spending picked up and credit growth accelerated in the second half of 2015. Accommodative macro policies are projected to continue supporting activity over the remainder of 2016.
The current account surplus is projected to decline to 2.5 percent of GDP this year (from 3 percent of GDP in 2015) as imports increase and the services deficit widens with continued outbound tourism. The balance of payments came under pressure in 2015 due to large capital outflows, mainly related to repayment of external debt. The volume of outflows is expected to moderate this year. After appreciating 10 percent in real effective terms through mid‐2015, the renminbi has depreciated some 4.5 percent since then and remains broadly in line with fundamentals.
Executive Board Assessment
Executive Directors commended the Chinese authorities for their strong determination to achieve more balanced, sustainable growth. They noted that economic growth continues to moderate and is driven increasingly by services and consumption. Directors welcomed the impressive progress on structural reforms in many areas, notably interest rate liberalization, internationalization of the renminbi, and urbanization. They also welcomed the 13th Five‑Year Plan, with its ambitious goals centered on economic rebalancing.
Directors noted that China’s economic transition will continue to be complex, challenging, and potentially bumpy, against the backdrop of heightened downside risks and eroding buffers. They stressed the need for decisive action to tackle rising vulnerabilities; reduce the reliance on credit‑financed, state‑led investment; and improve governance, risk pricing, and resource allocation in the state‑owned enterprise (SOE) and financial sectors. Directors emphasized that consistent, well‑coordinated, and clearly‑communicated policies are key to a smooth, successful transition, which will eventually benefit the global economy.
Directors highlighted the urgency of addressing the corporate debt problem through a comprehensive approach. They encouraged the authorities to harden budget constraints on SOEs; triage and restructure or liquidate over‑indebted firms; and recognize losses and share them among relevant parties, including the government if necessary. Piloting a few SOEs would make a strong start to the process. Directors
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Directors concurred that macroeconomic policies should be geared at lowering vulnerabilities, which would likely entail somewhat slower growth in the short term. They welcomed the authorities’ intention to rely on fiscal support if growth falls sharply in the near term. To this end, they saw merit in using on‑budget, pro‑consumption measures, which would help promote internal and external rebalancing. Measures could include raising pensions; increasing social, education and health spending; providing restructuring funds; and cutting minimum social security contributions. Continued efforts are also needed to ensure full implementation of the new budget law, improve fiscal transparency, and modernize the tax system.
Directors underscored the importance of further enhancing financial stability. Priorities include encouraging banks to proactively recognize loan losses and strengthen capital ratios; enhancing supervisory focus on liquidity risk management and funding stability risks; and addressing vulnerabilities in shadow products. Directors also recommended a major upgrade of the supervisory framework to foster cross‑agency information sharing and policy coordination, reduce the scope for regulatory arbitrage, and enhance crisis management capabilities. They looked forward to the forthcoming Financial Sector Assessment Program Update.
Directors noted the staff’s assessment that the renminbi is broadly in line with fundamentals, although the external position in 2015 was moderately stronger than consistent with fundamentals. They welcomed steps toward an effectively floating exchange rate regime and encouraged the authorities to build on this progress while carefully managing the transition, and with the support of a more market‑based monetary framework. Directors supported a cautious approach to capital account liberalization that is carefully sequenced with the progress on exchange rate flexibility and financial sector reforms.
Directors encouraged the authorities to continue to improve data quality and policy communications, which would help reduce uncertainty, align expectations, and guard against market turbulence.
Source: https://www.imf.org/en/News/Articles/2016/08/11/20/37/PR16374‐China‐IMF‐Executive‐ Board‐Concludes‐2016‐Article‐IV‐Consultation
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