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Baoyun Qiao and Anwar Shah
departments that report to the State Council offer specific-purpose transfers from their own budgets. However, there is no clear procedure in the decision-making process to allocate the resources to provincial and subprovincial governments, and the arbitrary nature of central grant allocations has led to extensive negotiations by local authorities and encourages rent-seeking.
Local Government Borrowing Local governments are forbidden to borrow from commercial banks or from the capital market, except with special approval from the central government, according to China’s 1994 budget law and related regulations. In addition, local governments are prohibited from direct borrowing. In other words, only the central government can issue bonds or borrow on behalf of local governments from either domestic or foreign banks. The central government issued about US$75 billion in domestic bonds and US$1.5 billion in foreign bonds in 2003. About 10 percent of these bonds were for local governments. However, local governments frequently succeed in circumventing these restrictions by borrowing “off the books” through special projects and enterprise accounts. Meanwhile, locally owned enterprises can and do borrow from banks and on the capital market—despite their dependence on government subsidies of various kinds, which often makes them de facto government agencies. Given the still limited direct and indirect transfers from the center to provinces, such borrowing from local commercial banks by enterprises (under the jurisdiction of local governments) actually finances local capital investment and spending. In addition, most local governments provide implicit loan guarantees for SOEs, as the budget law prohibits explicit guarantees. Local governments also provide loan guarantees to the central bank for local financial institutions so that they can avoid financial risk. Debts to government employees—largely teachers of elementary and secondary school and to vendors providing products or services to governments—are also a main channel of local borrowing. Local governments, particularly county and lower-level governments, are responsible for salaries of teachers in elementary and secondary schools. Because of serious fiscal difficulties, governments at these levels in poor jurisdictions usually are not able to pay the full salaries. The unpaid part becomes the local debt. Local governments in poor jurisdictions may also not be able to pay farmers for their agricultural products. In such cases, farmers who sell their products
