Across The Border

China’s government debt woes might worsen in 2016

Debt burden could rise further if the underlying growth remains weak and the yuan keeps falling, analysts say

PUBLISHED : Thursday, 03 March, 2016, 12:37pm
UPDATED : Thursday, 03 March, 2016, 12:37pm

China’s rapidly-increasing government debt poses great risks to the country’s financial system and the economy, and the debt burden could rise further if the underlying growth remains weak and the yuan keeps falling, analysts say.

China’s general government debt increased to about 53.2 per cent of the country’s GDP by the end of 2015, versus 50.6 per cent a year earlier, according to Fitch Ratings’ latest estimates. Local government debt expanded even faster, up to 33 per cent of GDP at the end of 2015 from 21 per cent of GDP at end-2013.

“The degree of leverage in China’s economy has increased dramatically since 2008, even as the pace has slowed since 2013,” Fitch said.

The rating agency noted that China’s bank-dominated financial system faces mounting risks, as its standalone credit strength is weak for the sovereign rating level. As a result, the Chinese sovereign faces “a large and rising contingent liability”.

Besides, the recent depreciation of the Chinese yuan is taking a toll on local government offshore funding plans, Fitch said.

“If the Chinese currency keeps depreciating, LGFV (local government financing vehicles)’s offshore debt servicing costs will continue to rise as they pay more in local-currency terms,” Lin Pei and Terry Gao, analysts for Fitch, said in a recent report.

“The impact will be largest on debt denominated in the US dollar, which has appreciated sharply against the yuan and accounts for the majority of LGFVs’ offshore debt,” they added.

Fitch predicted China’s government debt level to increase to about 54 per cent of GDP in 2016. However, the ratio may start to come down afterwards, as the authorities move to address the local government debt problem, it said.

Moody’s Investor Service appears more pessimistic on the outlook of China’s government debt.

On Wednesday, Moody’s surprised markets by downgrading the outlook on China’s government bond rating to negative from stable, citing “rising government debts” and “large and rising contingent liabilities on the government balance sheet” as a key driver.

“The government’s balance sheet is exposed to contingent liabilities through regional and local governments, policy banks and state-owned enterprises (SOEs),” said Marie Diron and Anne Van Praagh, sovereign analysts at Moody’s. “The ongoing increase in leverage across the economy and financial system and the stress in the SOE sector imply a rising probability that some of the contingent liabilities will crystallise on the government’s balance sheet.”

Besides, as the Chinese government and the banking sector step up support to implement strategic national policy goals, and the government has made clear their objectives to introduce more market discipline, contingent liabilities could see continued growth, the rating agency added.

Looking ahead, the fiscal strength of the Chinese government could weaken further if the underlying growth remained weak, Moody’s warned, although it added this is not its “base case scenario”.

If that happened, the liabilities of China’s policy banks would likely see them increase their efforts to fund government-sponsored investment, and the leverage of SOEs, which is already under stress, would rise further, Moody’s noted.

The degree of leverage in China’s economy has increased dramatically since 2008, even as the pace has slowed since 2013
Fitch Ratings

In particular, rising SOE leverage would raise the risk of a sharp slowdown in economic growth, as paying debt will constrain the government’s other spending.

In addition, it may also cause a “marked deterioration” of bank asset quality.

“Either of these developments could ultimately result in higher government debt and additional downward pressure on the government’s credit profile,” said Moody’s.

Moody’s estimated China’s government debt at 40.6 per cent of GDP at the end of 2015, up from 32.5 per cent in 2012. It predicted China’s government debt to further increase to 43 per cent by 2017, as the policymakers are expected launch accommodative fiscal policies, with higher government spending and possible reductions in the overall tax burden.

Nevertheless, Moody’s expects China’s debt affordability to remain high, as the country’s large domestic savings may continue to fund government debt.

The Chinese central government has already accelerated efforts to curb the borrowing by local governments and rein in risks related to their rising debt level.

Last week, several state agencies, including the central bank and the finance ministry, jointly issued a new rule to ban local governments from borrowing from banks to purchase land and conduct other property projects, in an effort seen to reduce risks in the banking system, as local government borrowing accounts for a large part of banks’ non-performing loans.

However, Standard & Poor’s said in a recent report that the new rule may not be “a quick fix” for the local government debt problem as it has limited impact on the entities’ creditworthiness.

“The creditworthiness of LGFVs ultimately remains underpinned by their strong ties and importance to their local governments, and the credit strength of those governments,” said Standard & Poor’s credit analyst Gloria Lu.