After the US debt crisis, time to focus on China
All eyes have been on Washington debt. In the coming days, it will be China’s turn. Figures soon to be released by the National Audit Office will help cast light on just how much debt China has racked up since Beijing greenlighted a nationwide program of infrastructure construction to prop up the economy during the global crisis.
Importantly, the figures will provide a snapshot of the fiscal health of local government financing vehicles (LGFVs). That includes at least 10,000 separate legal entities spanning four levels of government administration – right down to individual townships. Many of these LGFVs played a big role in funding highway construction and social housing, projects that were pillars of China’s Keynesian stimulus package launched in late 2008.
Getting an accurate gauge of the debt situation hasn’t been easy. Underscoring the scale of the accounting problem, thousands of central government auditors since July have set out to examine the books of around 10,800 local government entities, of which only about 900 produce regular financial statements as part of their obligations as public bond issuers. What’s more, a portion of the debt held by these LGFVs is in the form of intercompany loans and IOUs.
It’s not hard to image regional entities being reluctant to come clean about all liabilities.
The audit is slated to be released ahead of the annual Communist Party meeting in November. The timing could be more than coincidence according to Standard Chartered, which noted next month’s meeting is the first with Finance Minister Lou Jiwei at the helm. Unveiling the scale of the debt problem to the public could “help the MOF garner higher-level support for a big fiscal reform package, and approval for sterner measures to get LGFVs under control,” according to Standard Chartered analysts in Shanghai.
Early indications of the scale of the problem are a worry. Comments given in September by three central government officials, including Xia Bin, a senior economist formerly with the research arm of the State Council, who cautioned publically of an “astonishing” number, were telling according to Standard Chartered economist Stephen Green. He estimates China’s local government debt could be as high as 24.4 trillion yuan as of June 2013 – or nearly double the current official estimate.
Japanese bank Nomura tags the figure at a lower 19 trillion yuan at the end of 2012. It warned, however, of major risks. Half of the debt owed by LGFVs would have slipped into default last year if it hadn’t been for the financial support of local governments, the bank said. Debts accumulated by LGFVs since 2009 were “massive” and “now pose a major risk to the economy,” Nomura analysts said in a recent research note. Nomura said it conducted its stress test using international accounting standards.
The Japanese bank estimates the majority of LGFVs can remain solvent only with the help of government life support. Moreover, if interest rates were to rise, the situation would rapidly destabilize. Every 1 percentage point rise in interest rates means an additional 10.4% of LGFV debt will become “non-sustainable”, Nomura said. More than a third of all LGFVs have no income and are reliant on new borrowings to fund projects, it noted.
Also worrying is the potential for the woes piling up among LGFVs to spark a crisis in the banking sector. Of the funds owed by LGFVs, about half are in the form of short-term loans originated by publicly-listed commercial banks and trusts, according to Bank of America-Merrill Lynch economist Ting Lu.
Lu thinks these concerns are likely on the minds of China’s central planners – and could be behind what he believes is a strategy that will see the central government take on more debt in an attempt to help deleverage local governments. The changes could include helping LGFVs replace short-term bank loans with longer-duration bonds. Another option would see the central government transfer some of the short-term loans owed by LGFVs directly on its own balance sheet.
Merrill's Lu doesn’t think China is headed into a financial crisis anytime soon. Still, he notes one worrying sign: the dwindling effect of new debt in spurring economic growth.
In the four-and-a-half years through June 2013, China’s overall debt rose at an average annual rate of 22%. During the same period however, the economy grew at a nominal annualized rate of 12.9%.
“The growth pace of debt has been significantly higher than the nominal GDP growth rate in the past two years,” Lu said.