China's local debts threaten crisis
By Olivia Chung
HONG KONG - China's local governments, which have increased spending under the
central government's massive 2008 economic stimulus, have run up debts to
levels that could pose a threat to the economy, according to some economists.
Eighteen provincial, 16 city and 36 county-level governments that were audited
had accumulated debts of 2.79 trillion yuan (US$412 billion) by the end of last
year, according to the National Audit Office.
About 9% of new debts in 2009 were invested in the central government's four
trillion yuan stimulus package projects initiated from late 2008, and a
considerable proportion of last year's loans were used to finance transport and
other infrastructure facilities started before 2008, it said. The audit report
said most of the 2.79
trillion of debt was used to fund infrastructure construction.
"The pressure from some government debt burdens is quite heavy, and poses a
definite risk," audit office director Liu Jiayi said in the report. "New
government debt must be strictly controlled to prevent financial risks from
evolving into fiscal risks."
Seven provincial governments, 10 city and 14 county-level governments studied
had overspent their incomes, with one provincial government having spent three
times what it had available, Liu said in the report posted on the website of
the audit office. The report did not name the governments, only saying the
western region bore the higher levels of debts.
Of the total loans, about 60%, or 1.04 trillion yuan, were secured last year,
with the rest dated from 2008 and before, the report said.
According to China's Budget Law, adopted in 1994, local governments are
required to have balanced budgets. They are banned from issuing debt, securing
bank loans or using government assets as collateral for loans. They can borrow
only from the central government or other central authorities.
However, many local governments for years have used local investment companies
as a way to bypass the law to borrow and fund their development projects,
including infrastructure and real estate projects. Local governments inject
land and cash into the investment companies to give it assets as collateral
against loans from local banks.
About 8,200 financing vehicles have been set up by local governments, according
to the China Banking Regulatory Commission (CBRC). But how much the local
government-controlled companies have borrowed to date and how they use they
funds are unclear.
The CBRC said in March that outstanding loans to these vehicles totaled 7.38
trillion yuan by the end of 2009, 20% of the country's total loans and
representing a 70.4% surge from a year earlier. It also said some of the
massive loans to government financing vehicles had become questionable, without
disclosing the amount.
Victor Shih, a professor at Northwestern University in Illinois, estimated
loans raised by local governments through financing vehicles between 2004 and
2009 reached 11.4 trillion yuan, representing more than one-third of the
country's gross domestic product (GDP) of 33.5 trillion yuan in 2009.
About 7 trillion yuan of the total borrowing was borrowed for infrastructure
spending and 4 trillion yuan for "other" purposes, according to Shih's study,
Shih said that if existing credit lines were fully drawn down, total local
government borrowing could swell to 24 trillion yuan by the end of 2012, which
would lead to a large-scale financial crisis.
A recent report by the People's Bank of China, the central bank, focused on
worries over local borrowing in Tianjin municipality, near Beijing, where loans
to local government entities doubled last year to 432.5 billion yuan. The
municipality's GDP rose 16.5% last year to 750 billion yuan.
At the end of 2008, Beijing unveiled a 4 trillion yuan investment expansion
plan and maintained a relaxed monetary policy as part of its efforts to combat
the global economic downturn. The central government paid for only one-quarter
of the stimulus plan while the rest came from state companies and borrowing by
lower-level governments from state banks.
Mainland banks extended a total of 9.6 trillion yuan in loans to support the
plan last year, almost double the minimum target of 5 trillion yuan.
Despite the concern, some economists believed the nature of the debt and
amounts would not lead to local or national crises.
"Given that the increasing loans are related to the stimulus move launched by
the central government and the higher levels of debt are borne in the
developing region, the central government will definitely offer help to solve
the problems," said Wu Xiaoling, a former central bank vice governor.
Guo Tianyong, a professor of finance at the Central University of Finance and
Economics, said the nation's debt level was still prudent as it accounted for
only 47% of gross domestic product.
Shi Hongxiu, a finance professor at the Chinese Academy of Governance, told
Asia Times Online that this audit report was alarming because the mounting debt
could pose a threat to macro-economic stability.
"The macro-economic instability stems from the ineffectiveness of our
macro-economic management tools. For example, interest rates can be used by the
governments as a way to help the economy operate at optimum levels. However,
when [local] governments are involved in borrowing and investing through their
investment vehicles, which are companies without much worry about repayment or
inflation, the effectiveness of macro-economic policy will be impeded," Shi
"There is an even worse scenario. Unlike Western market economies, local
governments in China have a duty to shore up growth. If the governments do not
abide by the Budget Law and fund their pet projects to maintain growth
regardless of the projects' future profitability, while state banks lend to
government companies regardless of their ability to repay, the lending spree
will backfire, with a soaring number of non-performing loans, and affect
Shi referred to the early 1990s, a period of overheating in the Chinese
economy, when soaring local government debt plagued banks across the mainland.
Inflation rose to 21% in 1994 - its highest over the past 30 years - and much
local debt ended up as non-performing loans, climbing to 40% of total credits
in the state banking sector in the mid-1990s. This prompted the central
government to tighten lending, resulting in prolonged deflation in the late
Yi Xianrong, a researcher with the Institute of Finance and Banking under the
Chinese Academy of Social Sciences (CASS), told Asia Times Online that the
threat to the economy posed by the large debt burden was that a fall in
mainland property prices might erode the value of the land that local
governments' financing vehicles had posted as collateral against their
borrowing, which could lead to a sharp rise in non-performing loans for banks.
Banks in Shanghai may face a combined loss of 5 billion yuan, or 8% of their
pre-tax profits in 2009, if property prices drop 30%, the Shanghai bureau of
the China Banking Regulatory Commission said last month.
Wharf (Holdings) chairman Peter Woo Kwong-ching said earlier that mainland
property sales and prices could drop as much as 30% this year due to the
central government crackdown on property speculation. However, while property
sales volume has plummeted, prices so far remain stable.
Realty prices in 70 major cities nationwide rose 12.4% year-on-year in May,
compared with a record 12.8% rise in April, figures from the National Bureau of
Statistics showed. The month-on-month increase was 0.2% in May, compared with
1.4% in April.
Chinese banks may need to set aside 283.1 billion yuan as bad loan provisions
over the next two years, which may reduce Chinese lenders' net profit,
according to the 2010 Blue Book for China Finance, the annual report on China's
financial development compiled by CASS.
"Loans extended to local financing vehicles, which are implicitly backed by the
unstable fiscal revenue of local governments, accounted for about 10% of the
total lending extended by listed Chinese lenders at the end of 2009," the
China Development Bank, the nation's state-run lender for public works, bears
the highest exposure to such loans, which account for 69% of its total loan
portfolio, the report said.
In mid-April, the state cabinet announced moves to cool the housing market,
including raising the minimum down-payment to second-home mortgages to 50% and
imposing an extra 10% interest rate on second home loans.
However, Lian Ping, chief economist at the Bank of Communications, did not
believe China's mounting debt would pose a European debt crisis as the
country's financial system is fundamentally different from that of Europe.
"The governments of European countries usually have to maintain high government
deficits to support their bloated social welfare systems, and the additional
spending to combat the financial crisis added a further burden to their
government finances. In China, even after the local debt is taken into account,
the scale of public debt is limited," Lian was quoted as saying by China Daily.
Beijing now closely watches the increasing debts of local governments, as the
problem has the potential to turn soar years later. In a circular to local
governments and ministries, the State Council last month asked officials to
categorize debts issued by local financing companies and banning certain public
assets from being injected into the investment vehicles. It ordered local
governments to improve management of such investment vehicles and told banks to
limit lending to them.
Wu Zhong, ATol's China Editor, writes:
The Chinese government has annual fiscal revenue of more than 30% of the GDP,
strong foreign reserves (US$2.45 trillion as in March), and manages state-owned
enterprises and banks with assets totaling 115 trillion yuan, so that its
assets still far exceed its current debts (both of the central and local
governments), Shi Hongxiu at the Chinese Academy of Governance argues,
according to Xinhua.
Moreover, with a high savings rate, the country has large bank savings (61.20
trillion yuan at the end of 2009, of which 26.48 trillion yuan was households
savings), so if there is a need the government could issue more bonds at any
time to easily raise funds at home.
Even so, the large scale of local government debt has to a great extent tied
Beijing's hands in applying more flexible macro-economic control measures.
For instance, to ease growing public anger over skyrocketing housing prices,
Beijing has issued toughly worded orders to cool down the market. But because
local governments have pledged land resources to borrow bank loans, they need
to keep land prices high so that banks will not recall their loans.
Again, it is generally agreed that China needs to increase interest rates to
curb inflation as consumer prices soared 3.1% in May, but any interest rate
increase would increase the financial burden of debt-laden regions.
Thus, instead of using the traditional monetary instrument to fight against
inflation, the National Development and Reform Commission now is assigned a new
job: to control people's expectations of inflation. It is not clear how it can
do this, beyond banning the media from reporting any forecast about possible
price increases in consumer goods.
For Premier Wen Jiabao, who will step down in March 2013, how well he handles
the problem of state and local debt is a huge challenge to his wisdom and
After the Asia financial crisis starting in 1997, Wen’s predecessor, Zhu
Rongji, tremendously expanded budget deficits for infrastructure investment. By
2002, a year before the end of his term, the accumulated state debt reached 2.5
trillion yuan. By comparison, China's five-year plan for 1996-2000 set the
goals of bringing down the budget deficit in 2000 to under 10 billion yuan and
accumulated state debts to under 300 billion yuan.
Some Hong Kong newspaper thus nicknamed him "The Deficit Premier". Zhu
obviously was upset by this. At his last press conference as premier at the
National People's Congress annual session in March 2002, Zhu said: "A Hong Kong
newspaper granted me an honorary title of 'The Deficit Premier'. I never accept
any honorary title or degree ... [With the deficit budgets] what we will leave
to the next government are not just debts but 2.5 trillion yuan worth
good-quality assets, which will ... contribute to future economic development
in the country ... So, sorry, I cannot accept the title of 'The Deficit
Premier', which I have to return to the sender."
In the past seven years or so of Wen's premiership, China's deficit and
government debts have spiraled. One may wonder what he will have to say in
justification before his retirement. Will he be able to proclaim, like Zhu,
that what he will leave to the next government are good-quality assets rather
than bad debts?
Olivia Chung is a senior Asia Times Online reporter.