China needs to tackle financial instability at local government level

PUBLIC finance is an important pillar of a country’s governance and plays a fundamental role in its modernisation. As China’s modernisation progresses, it needs to pay attention to preventing financial risks, make sure it has a certain degree of fiscal space in reserve, and improve the ability of the fiscal system to deal with potential risks.

Three requirements are involved here. First, public finance needs to ensure that governments at all levels can carry out their functions. Second, various indicators of fiscal sustainability need to be kept within a reasonable range, including the government’s ability to borrow a moderate amount of money at normal market interest rates. Third, the fiscal system needs to be resilient with enough space to adjust and respond to any major shocks to the economy and national security.

Although public opinion both at home and overseas is concerned about the potential financial risks caused by local government debt, the funding gap in social security, especially in pensions and medical care, may in reality be the biggest challenge to China’s financial security.