China's prolonged property market downturn has exposed deep structural vulnerabilities in a local government financing model that depended heavily on land sales and off-budget borrowing, with the resulting fiscal strain increasingly weighing on businesses, workers, and overall economic growth, according to an East Asia Forum report. The findings underscore how a model that once powered China's infrastructure boom has become a systemic liability.

How Land Finance Fuelled a Decade of Growth

Following China's landmark 1994 tax-sharing reform, local governments were left responsible for a disproportionately large share of public services and development expenditure, even as their formal revenue-raising powers remained constrained. To bridge this gap, they turned to two mechanisms: selling land-use rights and borrowing through off-budget financing vehicles, routinely using land assets as collateral.

This model delivered real results for a period. It funded large-scale infrastructure, accelerated urbanisation, and reinforced China's investment-driven growth engine. It also incentivised local officials to compete aggressively for investment and economic expansion. However, the heavy dependence on land revenues left local finances acutely exposed to the property cycle.

The Scale of the Collapse in Land Revenue

At the height of China's housing market in 2021, broadly defined land-related revenue — encompassing land-sale proceeds and associated taxes — accounted for nearly half of local governments' consolidated revenue, equivalent to approximately 10 per cent of GDP. By 2025, that share had contracted sharply to around 25 per cent of local revenue, or less than 5 per cent of GDP.

Notably, the report cautions that actual land demand may have been weaker than these figures suggest. Local government financing vehicles themselves reportedly purchased large volumes of land during the boom years, effectively inflating reported land-sale revenues and masking the underlying weakness in organic demand.

Debt Servicing Burden Rises Sharply

The collapse in land-related income has since laid bare the scale of debt accumulated during the boom. Between 2019 and 2023, debt servicing on official local government debt — covering both principal and interest — climbed from around 8 per cent of local revenue (before central government transfers) to 18 per cent, according to the report.

The pressure is equally acute for off-budget borrowing. Much of this debt was extended against land collateral during the property boom, leaving financing vehicles increasingly exposed as land prices and transaction volumes weakened. In heavily indebted provinces such as Guizhou, local authorities have openly called for greater support from Beijing as their capacity to manage mounting obligations comes under strain.

Broader Economic Fallout

The fiscal squeeze is not confined to government balance sheets. Constrained local budgets translate into delayed payments to contractors, wage arrears for public sector workers, and curtailed spending on social services — all of which feed back into weaker domestic consumption. Critics argue that without a fundamental restructuring of intergovernmental fiscal arrangements, the debt overhang will continue to act as a drag on China's economic recovery. This comes amid broader concerns about deflationary pressures and sluggish private investment that have defined China's post-pandemic trajectory.

The trajectory of Beijing's response — whether through direct bailouts, debt swaps, or a longer-term overhaul of how local governments raise revenue — will be closely watched as a signal of the central government's appetite for structural reform.