China moves to defuse local government debt bomb

Finance Ministry tells several local provinces to investigate possible illegal loan guarantees, part of a wider problem of ‘misaligned incentives’

PUBLISHED : Monday, 27 February, 2017, 9:00am
UPDATED : Monday, 27 February, 2017, 9:00am

China’s Finance Ministry is investigating possible irregularities in the ways several local governments have obtained loans, as part of ­wider efforts to keep borrowing in check and avoid widespread ­defaults.

According to a notice seen by the South China Morning Post, the ministry last month asked provincial governments in Inner Mongolia, Shandong, Henan, Chongqing and Sichuan to address the irregularities.

The notice was copied to the Ministry of Commerce and the China Banking Regulatory Commission, asking the two bodies to pay special attention to the institutions involved.

Local governments have racked up sizeable debt, often via financial vehicles, to back massive infrastructure or public projects that have little chance of eventually generating cash flows to repay the loans.

China ‘to keep 3 per cent budget deficit in 2017 as debt risks grow’

To tackle the problem, the central government has been bailing out local governments by swapping debt for long-term, low-interest bonds. By the end of last year, the mainland had converted 8.1 trillion (HK$9.1 trillion) worth of debt through such ­transactions.

But local officials are finding ways to skirt the rules. In one case in the ministry’s notice, the Zhumadian government in Henan province promised to guarantee a loan of 640 ­million yuan from China Construction Bank that was given to a financial vehicle controlled by the local government.

Under the budget law that came into force in 2015, local governments are forbidden from guaranteeing loans and can only raise funds through bond issuances approved by the ministry.

Du Li, executive director of the Centre for Public Economy Research at Fudan University, said the ministry’s move to name and shame a handful of local governments could help reduce irregularities, but they can “hardly get rid of the root problem”. Many local authorities have resorted to alternative channels for financing, such as public-private partnership projects, to bypass finance ministry regulations.

‘No bailouts’ in China’s plan to tackle local government debt pile

The issue could become more pressing this year, with cadres eager to report strong economic growth as they seek promotions amid a wider power reshuffle.

Sixteen provinces are planning to increase the size of their investments compared to last year, while the combined investment target of 23 of the nation’s 31 provinces has already hit 40 trillion yuan – approaching the national total of 49 trillion yuan last year.

Moody’s rating agency said in a report earlier this month that central and local governments had “misaligned incentives”, and the problem was inhibiting structural reform and slowing the country’s rebalancing away from an overreliance on investment as a source of growth.

The State Council has been preparing for unwanted scenarios. Last November, the cabinet listed four types of debt risk and corresponding emergency responses – a sign of its reluctance to bail out local governments.

Recommended measures ­include suspending tax credits, ­cutting expenditure and selling assets.