It's panic stations as the debt train starts to pull in

PUBLISHED : Friday, 21 October, 2011, 12:00am
UPDATED : Friday, 21 October, 2011, 12:00am


As the signs mount that the nation's economy is slowing, two announcements yesterday show how Beijing is getting increasingly nervous about the debts piled up by different arms of government.

First, the Finance Ministry said it would allow the provincial governments of Guangdong and Zhejiang, as well as the municipal authorities of Shenzhen and Shanghai, to issue their own bonds.

Letting local governments issue bonds has become a matter of urgency lately. Over the last three years the deficits incurred by mainland local governments have soared as they increased spending in response to Beijing's orders. Last year, combined local government deficits hit 3.3 trillion yuan (HK$4 trillion) (see the first chart above).

That was partly offset by fiscal transfers from Beijing, but even so the local governments were still over a trillion yuan in the red last year. As a result, local government debts have ballooned, reaching 10.7 trillion, or more than 25 per cent of gross domestic product, at the end of last year, according to the National Audit Office.

Around 8.5 trillion of that has been borrowed from the state banks, much of it in the form of short-term loans taken out to fund long-term infrastructure projects. With few of these projects likely to generate any revenues in the near future, analysts have grown more and more doubtful about the ability of local governments to service these loans.

If the economy now slows, that ability will be further eroded. Last year, local governments relied on a combination of land sales and property taxes to generate 56 per cent of their revenue. If the economy softens and property prices fall, much of that income will evaporate, exacerbating the size of local government deficits and possibly triggering widespread defaults by cash-starved local government projects.

By letting local governments issue bonds, Beijing is effectively allowing them to extend the maturity of their debts from short-term loans to longer-term bonds. Hopefully that will buy sufficient time for local infrastructure projects to begin generating enough cash to repay the debts incurred in their construction.

Whether the plan will work is another matter. Nervous of a bubble in local government bond issuance, Beijing imposed severe restrictions on the size of issues. This year it has set a quota of 200 billion yuan, which is far too small to relieve local governments' funding problems. If growth slows, a much bigger quota will be needed next year.

Second, the National Development and Reform Commission, the nation's top economic planning body, declared that bonds issued by the Ministry of Railways have 'government support'.

This will come as a relief to holders of the bonds, who have become more and more fearful of a default as stories of a cash crisis in the country's railway system have multiplied.

Over the last five years the debts of the railway ministry have tripled as it launched a massive programme of investments in the country's network. Last year, investment topped 840 billion yuan, pushing railway ministry debt up to 2.1 trillion yuan, or more than 5 per cent of GDP (see the second chart).

Servicing this debt mountain looked tricky even before July's high-speed-train crash in Wenzhou. With the rail system's debts growing far faster than its income, the ministry faces problems servicing its debts from revenue.

And with the mainland's banks limited in the amount of exposure they are allowed to have to individual borrowers, there are rumours that the ministry has found it increasingly difficult to borrow.

Since the Wenzhou crash, those problems have multiplied as the railway system has suffered a crisis of confidence. Analysts have even whispered about the possibility of a Ministry of Railways default.

Yesterday's declaration by the NDRC should shore up confidence in the rail system's finances, but some form of bailout still looks necessary, with the Finance Ministry assuming responsibility for the Ministry of Railways' debts. Otherwise the rail system could suffer another nasty crash.