Local government debt signals rising risks in Chinese financial system

Local governments owe HK$23 trillion, underscoring dangers to the economy, but experts say country not on brink of debt crisis

PUBLISHED : Monday, 30 December, 2013, 9:06pm
UPDATED : Wednesday, 01 January, 2014, 6:25pm

Mainland local government debt had swollen to 17.9 trillion yuan (HK$22.7 trillion) by the middle of this year, according to the National Audit Office (NAO).

The figure is nearly 70 per cent more than previously disclosed, and will be seen as a further sign of the risks building inside the financial system of the world's second-biggest economy.

The disclosure, made on the NAO website, came as researchers at the China Index Academy forecast local governments' land sales revenue would hit a fresh record above 3 trillion yuan this year as they try desperately to raise funds to meet obligations.

The most comprehensive survey of debt across all levels of local government on the mainland delivered the most startling figure to investors since the disclosure in 2011 that local governments had racked up debts worth 10.7 trillion by the end of 2010.

"We believe the markets and the Chinese government should be alarmed by the rapidly rising leverage, but we do not believe China is on the brink of a debt crisis," Ting Lu, chief China economist at Bank of America Merrill Lynch, wrote in a note to clients.

Investors had been expecting a total close to 20 trillion yuan after former finance minister Xiang Huaicheng raised that possibility in April.

The NAO report maintained that government debt risks were under control in general, but conceded that "there are potential risks in some places".

The report revealed 10.9 trillion yuan of direct local government debt as of June, about 2.7 trillion yuan of credit guaranteed by local authorities and 4.3 trillion yuan of contingent liabilities. Central government debt stood at 12.4 trillion yuan, bringing the total to 30.3 trillion yuan.

The risk of widespread default rippling through the Chinese banking system is one of the greatest fears of global investors, who believe that vast swathes of debt have already turned sour and that lenders are rolling over bad loans rather than admitting they will never be repaid.

The NAO's report lends further weight to the findings of the quarterly "China Beige Book" (CBB) survey, which said earlier this month that the number of firms getting new credit shrank for the seventh consecutive quarter while the proportion of loans going to debt rollovers jumped.

Only 14 per cent of bankers questioned in the CBB survey said 30 per cent or more of their branch lending went to new customers in the fourth quarter, down from 18 per cent in the previous quarter and 40 per cent in the second. Meanwhile, only 33 per cent of firms said they had applied for loans this quarter, down 13 points from the third quarter.

Ratings agency Fitch has been one of the most bearish on the debt risks building in the financial system and cut China's sovereign debt rating in April, citing a lack of transparency in the increased borrowings of local government.