• Fri
  • Oct 31, 2014
  • Updated: 7:50pm

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.


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According to Oscar Wilde, 'whenever people agree with me I always feel I must be wrong.'
Of course I'm no Oscar Wilde.
But whenever people disagree with me I always feel I must be correct.
The dark side of the Chinese economic miracle. The bubble has to burst sooner or later in a country which has benefitted solely from foreign investment, foreign technology and foreign know - how without any original input by itself.
Municipal bond is part of China's debt market, which must be well developed if Renminbi is to be internationalized and used as one of the world's reserve currencies.
If the cost of refinancing is too high, say because of relatively high borrowing rates under a credit crunch, the local governments may consider selling part of their assets to repay part of the debts, especially if the prices of the assets are still high.
Some people think that under a liquidity crisis, it is better to sell assets than to refinance the present debts.
It is even suggested that China should experience a hard landing. The plate can be wiped clean (defaults should be allowed ) and everything can be restarted anew.
Anyway there should be no shortage of revenue to cover the debts.
Edmund Burke (1790) succinctly asserted over two centuries ago: "The revenue of the state is the state. In effect all depends upon it, whether for support or reformation."
Perhaps he is still correct today, provided the revenue is collected in a legal way.
So long as the RMB and the manufacturing economy remain strong, there is no need for debt financing of necessary infrastructure and development projects. The PBOC could provide the necessary funding. Central government bonds are issued for investments by the banks and other investors with excess cash.
Local governments should not be encouraged to borrow money for pet projects. Such projects should be funded by revenue surplus from normal government operations. Local governments should also live within their means and have no debt problems.
"Internationalization" of the RMB is only needed for foreign trade and investments. China should not be too concern about the RMB being one of the world's reserve currencies. Such a reserve currency status would come naturally when the RMB is well managed and widely used for China's foreign trade and investments.
So a "hard landing" for China would be self-inflicted and unnecessary. It is only good for sinophobes and others wishing for a financial crisis or worse for China.
Some people suspect that the actual debt figures should be much higher than officially reported.
After preventing the local debts from growing too quickly, municipal bonds can be issued by the local governments to better match the maturities of the debts and assets.
A bond quota for each locality may have to be imposed to prevent abuse.
Local governments are seldom faced with having to "pay off" their debts.
Of course, they might choose to do so, but mostly they just roll them over,
by obtaining new loans or issuing new municipal bonds.
The issuing of local government bonds is bad idea for China. In China, the local government also function as part of the central government as their officials are appointed by the central government and responsible to the central government. This is unlike most other countries.
The criterion of promotion of local government officials, based on regional GDP growth, has to be revised.
The local governments' demand for loans is interest insensitive --- interest rate liberalization (higher interest rate) can't prevent the local debts from rising further.
Beijing's explicit announcement, that the local governments won't be bailed out, and that the present local officials in charge (not those in the next term) will be held fully responsible for the present debt problems, will effectively and quickly prevent the local government debts from growing further.
The banks have already been wary of lending to the local governments.
The announcement will also discourage the shadow banking system from lending to them.
Such an announcement regarding the local government debts for necessary infrastructure and other central government approved projects is both unnecessary and unfair. Such debts are the responsibility of the central government and should be funded, in the first place, by the PBOC. With a very strong RMB and manufacturing economy, China is in enviable position here. Local governments should only be responsible for their own pet projects and loss owing to corruption and other malpractices.
Somehow, its always "under control." I think everybody knows that the debt burden will be an obvious problem when it blows up and they cannot hide it.....until then, they will always tell you not to worry.
Funding for Central Government approved infrastructure and other development projects should be done through policy banks funded by PBOC. This would avoid the unnecessary confusion of the debt problems in China’s commercial banks which should be conservative with depositors’ and other bank customers’ money. Banks should not be de facto gambling houses or Ponzi schemes. Excess cash in banks could be invested in treasury bonds of the Central Government and liquidity could be ensured by selling these bonds back to the PBOC or in the bond markets.
It is important that banks should not be forced to lend other people’s money to sub-prime borrowers.
Creditworthy small and medium enterprises could obtain long term loans at reasonable interest rates from a policy bank funded by the PBOC.
China should take advantage of the strong RMB and her manufacturing economy.
Shadow banking system and other illegal schemes are systemic corruption that should be severely and thoroughly dealt with. Their consequences for the country are much worse than traditional corruption involving millions of yuan
Debts per se are not critical problems when the money is invested by the government in needed infrastructure and real assets that enhance the economy. They become very serious problems when they are squandered on bottomless consumption and out-of-control military expenses. The only sustainable rising consumption is based on income growth of the consumers from enhanced earning powers.




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