Body
What’s going on with Chinese local government debt? The question has come to the forefront over the past several months with questions about both the size and severity of Chinese local government debt burdens.
Direct borrowing by local governments is mostly restricted in China. In order to circumvent these restrictions, local governments have turned to affiliated organizations, such as local investment companies (LICs), to take on debt and finance projects. The result has been that local debts have become incredibly complex and difficult to track, leading many to wonder whether an unseen crisis may be brewing.
These concerns have been exacerbated by recent stories of LICs struggling to service their debt burden, local government bond issuances coming up short on willing investors, and rating agencies taking a harder stance on LIC debts.
Size of Local Government Debt:
Much of the debate has centered around the actual size of debt taken on by local governments.
The 2010 Regional Financial Operations Report put out by the People’s Bank of China (PBoC) shed some light on the scale of the debt problem earlier this year. The report gave no specific figure for local government debt, but stated that loans to LICs did not exceed 30% of outstanding rmb loans. Some analysts did their own back of the envelope calculations (30% of 47.9 trillion loans outstanding) and came up with an estimate of 14.4 trillion rmb in loans outstanding to LICs.
After the 14.4 trillion figure began gaining traction in the media, a PBoC official issued a clarification statement that 14.4 trillion rmb was far too high and the actual figure was closer to 9 trillion rmb.
At the end of June, China National Audit Office (CNAO) released a report detailing local government debts after an exhaustive audit of 25,500 local government offices and 6,500 LICs.
The report stated that by the end of 2010, provincial, city, and country governments had amassed 10.7 trillion rmb in debt, with 46% of the total belonging to LICs.
Notably, the report included fairly direct criticism of poor lending standards in loans to LICs and the off-budgetary nature of much of local borrowing. The CNAO report revealed that a significant number of local governments have overdue debts and are taking on new leverage in order to pay their existing debts. It also estimates that local governments have wasted 244 billion rmb in misused investments.
The CNAO reports was generally well received, but Moody’s subsequently cast a bit of doubt upon CNAO’s numbers, stating that the 10.7 trillion figure may have underestimated the actual size of debts by as much as 3.5 trillion yuan. Moody’s appears to have come to these numbers through selecting a midpoint between the lower CNAO report and the higher PBoC report.
Although the exact number may be up for some debate, it seems pretty clear at this point that local government debt were at least 10.7 trillion yuan in 2010 and have likely continued to grow in 2011.
Differing Liabilities of Local Government Debt:
One thing made clear by the CNAO report is that not all local debts translate into direct government liabilities.
The payment obligations are broken down into those with a direct government obligation, those with a government guarantee and those with a potential government obligation.
Local Government Debt Tenor:
According to CNAO the report, 48.9% of local government debt has been accumulated since 2008, lending credibility to the idea that local governments went on a borrowing binge as part of China’s stimulus efforts.
Of the 10.7 trillion in local government debt, approximately 80% (8.5 trillion) is in the form of bank loans.
These maturity profile of these banks loans is mixed, with some coming due relatively soon (mostly likely from old projects) and others not due until after 2016. Obviously the more short-term the structure of local government debt is the more important the issues of refinancing and liquidity become for local governments.
Debt Sustainability:
The key question is whether these debts sustainable or do they represent a threat to the Chinese economy?
Both the Ministry of Finance (MoF) and PBoC have come out with statements in the wake of the CNAO reports assuring the public that local debt levels are not dangerous. Mof official Jia Kang stated that local debt was equivalent to 27% of 2010 GDP, with total debt reaching 50-55% of GDP.
However, most analysts put the figure for total debt at around 70% of GDP after accounting for policy banks loans, Ministry of Railways debt, and liabilities from Chinese last NPL cleanup. This number gets even worse when you add in pension commitments and take a broad view of liabilities, leading some analysts like Victor Shih to place the number at up to 150% of GDP
While debt may not yet be at crisis levels nationally, individual localities may be faced with crippling debt burdens. The CNAO report reveals a 70.45% debt to financial resources ratio across of local governments. For 78 cities and 99 counties, this level is higher the 100%.
Even in the localities where financial resources are greater than debts, there is cause for concern. Much of the assets are likely in the form of land and therefore fluctuations in China's real estate market will have a large impact on local finances. Moreover, it’s unclear at this point how much of the revenue from land sales is already spoken for by other government commitments. Some localities have been relying on land sale revenues to finance the majority of their budget for years now. Stephen Green estimates that 50-70% of all land revenues would be required just to meet interest payments on these new debts.
Many of the loans taken out by local governments have been used to finance infrastructure projects. These projects are likely to have economically beneficial effects down the road as China, especially in 2nd and 3rd tier cities, still needs significant amounts of infrastructure development.
While these infrastructure projects will benefit long term growth, most will not provide the short-term boost in revenues needed to service these debts. With land revenues slowing in many areas and new requirements being placed on local governments to build affordable housing, the liquidity of local finances will be a major issue.
The central government has not been ignoring the situation and there was speculation earlier in the year that some sort of local bailout was in the works. However, officials recently have recently denied that anything of the sort it being planned.
We’ll continue to monitor the local government debt issue in this space. It’s fast become one of the most complex policy problems facing China’s economy.