The mainland's latest economic stimulus measures have exacerbated the already heavily laden balance sheets of provincial governments by encouraging them to take on more debt for infrastructure projects.
Massive spending on infrastructure projects is being undertaken by provincial governments, such as 829.2 billion yuan (HK$1.02 trillion) by Changsha, the capital of Hunan province, and a 3 trillion yuan stimulus by Guizhou province announced in July, despite the fact that provincial or municipal governments are still grappling with the legacy of the 4 trillion yuan package the central government launched between 2008 and 2010.
"It was actually much larger than 4 trillion. The 4 trillion was just a number announced. It was a massive expansion of bank lending. The size of the banking sector has exploded to double in the past three years," said Patrick Chovanec, a professor at Tsinghua University's School of Economics and Management in Beijing.
The government announced the 4 trillion yuan stimulus, but 12 trillion yuan was actually raised, mostly through local governments, Xu Chenggang, an economics professor at Hong Kong University, said.
At present, there is between 8 trillion and 9 trillion yuan of outstanding loans from that 12 trillion yuan raised for the stimulus, Xu estimates. Most of the money for the stimulus came from loans to local governments, which used land as collateral, he said.
"The central government has been trying to push down land prices. If land prices come down, either banks or local governments, or both, are in deep trouble. They still have to pay back their loans. Now banks are not willing to lend, as they are already in trouble."
Most of the nation's credit was locked up in projects with poor returns, Chovanec said. "When banks don't get paid back, they don't have money to make new loans."
New loans by the "big four" state banks fell to 166 billion yuan last month from 220 billion yuan in August, the 21st Century Business Herald reported.
Last month, the National Development and Reform Commission (NDRC) announced more than 1 trillion yuan of infrastructure projects to fight the latest economic slowdown.
"The current Chinese stimulus is not going to do better. The game can't be repeated any more," Xu said.
The 2008 stimulus had resulted in overcapacity in several industries, including the solar-energy sector, Chovanec said.
According to a report by investment bank Maxim Group, the debt of 10 of China's largest solar energy companies totalled 111 billion yuan. The report said LDK Solar, the world's second-largest producer of solar modules, and Suntech Power, the world's biggest maker of solar panels, were the most likely to go bankrupt.
"The decision to use the banks to front the money for China's stimulus essentially turned back the clock on decades of banking reform in China," Chovanec said.
Previously, the central government tried to turn domestic banks into commercial entities that lent based on risk and return, he said.
"The stimulus turned Chinese banks into slush funds, where money was available with no accountability."
The stimulus reversed much progress on governance reform, building up professionalism in the banking sector and cleaning up balance sheets, Christine Wong wrote in an Organisation for Economic Co-operation and Development report.
In a Hong Kong Institute of Monetary Research paper, Leo Goodstadt, a senior adviser to the HK government from 1989 to 1997, wrote: "The stimulus called for the reversal of a decade-long drive to halt local government borrowings, which were known to be a threat to financial stability.
"Former restrictions on local-government financial activities were suspended. New financial products and investment vehicles were affirmed even though they were untried, unregulated and mostly unlawful.
"It was foreseen that these developments would encourage a surge of illegal and imprudent lending."
Banks were encouraged to lend to local governments despite their poor credit ratings, the unlawful nature of such borrowings and the adverse monetary implications, Goodstadt added.
Chovanec said: "In 2009, the government told banks to lend cheaply. If you want banks to be accountable and efficient allocators of capital, you must give up control of the banks. Is the Chinese government willing to give up that control?"
In October 2008, the Ministry of Finance was struggling to find US$173 billion to support the stimulus, Goodstadt said. "The Ministry of Finance then gave consent to the sale of publicly owned land by local governments, reversing the previous policy of ending their dependence on land sales."
In 2009, land transactions generated 46 per cent of local government revenues and were sometimes associated with illegal land acquisition and soaring house prices, Goodstadt said. "The official view was that local governments had an almost irresistible incentive to promote real estate bubbles."
The NDRC acknowledged at a press conference that lower levels of the government had no legal power to borrow money or guarantee loans, yet an NDRC vice-director assumed that this legal restriction could be circumvented, Goodstadt wrote. "A lack of legality was a feature of almost all the anti-recession measures adopted in 2008 and 2009."
For example, the local government of a county in Guangdong province allocated US$570 million of the county's funds for unemployment benefits, tax concessions, business incentives and investment finance, Goodstadt added. "There appeared to be no legal authority to justify these initiatives, which did not deter the official media from hailing the county as a national model."
Early this year, the National Audit Office revealed it was seeking to recover from local government financing vehicles US$84 billion in misused funds borrowed in 2010. Subsequently, US$438 billion, a third of the financing vehicles' borrowings, were reclassified as general corporate loans, which enabled banks to reduce their provisions for these loans, Goodstadt wrote.
"Coincidentally, this sum was equivalent to 75 per cent of the US$586 billion [4 trillion yuan] stimulus."
"These were not just accounting exercises. They involved the destruction of substantial financial resources in a nation," Goodstadt wrote in another paper.
In the short run, the 2008 stimulus had positive impact on preventing a slowdown, Xu said. "In the long term, this was not a good policy."