Chinese local governments' debt risk is controllable

08:57, July 12, 2011      

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Local government debt accumulated over the past few years is relatively heavy, and some risks loom as certain regions and industries are weak in repaying the debt, according to a statement released by China's State Council after a meeting held on July 6 in response to international concerns over the massive debt burden of China's local governments. The repayment of debt and follow-up financing for projects under construction should be properly conducted, according to the statement.

Local governments' debt burden well below warning line

How heavy is the debt burden of China's local governments? According to a report released by the country's National Audit Office on June 27, local governments at the provincial, municipal, and county levels had amassed more than 10.7 trillion yuan of debt as of the end of 2010 and had repayment obligations for about 60 percent of the total sum. Only 54 county governments had zero debt.

The audit office has made great efforts to gain a clear picture of the debt load of local governments. In the first half of 2011, it deployed more than 40,000 auditors in the nationwide auditing of more than 79,000 local governmental agencies, 6,500 local government-backed financing vehicles, 370,000 projects and nearly 1.9 million lending agreements. It found that among the total local government debt, nearly 8.5 trillion yuan were bank loans. Certain regions had a debt ratio of more than 100 percent, and certain local governments were under heavy debt pressure from borrowing money to fund highways, hospitals, and colleges and universities,.

Will local governments be able to repay the debt exceeding 10 trillion yuan? Auditor-General Liu Jiayi said that local governments’ debt burden has not gone beyond their ability to pay off.

Jia Kang, director of the Research Institute for Fiscal Science under the Ministry of Science, said that according to the Maastricht Treaty, formally known as the Treaty on the European Union, the government debt-to-GDP ratio must not exceed 60 percent. Given China's huge GDP, the 10.7-trillion-yuan debt of local governments is well below the warning line.

China’s local government debt is made up of three types of debt: debt for which local governments have repayment obligations, contingent debt that local governments may need to pay and contingent debt for which local governments have obligations to render assistance. Local governments need to repay all of the first type of debt, and only part of the second and third types of debt, both of which are contingent debt. Even if local governments need to repay all of the 10.7 trillion yuan, the debt burden, which only accounts for over 20 percent of China's GDP, will still be below the warning line.

Related specialist agencies believe the 10.7 trillion yuan of local government debt has not exceeded the market expectations and is still controllable. Cao Honghui, director of the Department of Financial Markets under the Institute of Finance and Banking of Chinese Academy of Social Sciences, said that it will not cause systemic risk as long as China effectively deals with the non-standard and high-risk part.

Some local governments bear excessive debts

Although the total amount of local government debt is in the security range, the government should not ignore potential risks of local government debt.

Jia said that there are at least two reasons caused the excessive debts of some local public sectors. First, the transparency of local government debt was obviously low in the past. A large number of hidden debts were formed under unspoken rules and it is difficult for related departments to obtain the statistical information on those debts in a timely fashion. Second, the social cost to pour oil on troubled waters is very high once contradictions could not be concealed.

Experts speculate that according to the current audit results, the debt ratio of 78 municipal and 99 county-level governments is more than 100 percent, accounting for nearly 20 percent and nearly 4 percent of the total number of municipal and county-level governments respectively, indicating relatively large potential risks. More than 70 percent of debts are used for railway investment and bridge and land purchase. This indicated that the assets of local governments would increase along with the increase in liabilities.

Large-scale debt is also a test to the banking industry. Bank loans accounted for nearly 80 percent of the total 10.7 trillion yuan of debt. Financial expert Ye Tan believes the default rate of the current local government debt may far exceed the previous size of banks' bad loans because banks mainly indirectly finance bad loans. Therefore, the negative impact on China's banking in the post-crisis era is far from over.

Adopting multiple measures to reduce risk

Effectively reducing debt risks facing local governments has topped the agenda of the central government in its efforts to rectify last year’s auditing problems. The State Council said during an executive meeting that the problems relating to debt repayment and follow-up financing of local government projects under construction should be handled properly under the principle of making classification management and taking different approaches to different problems.

The central government will continue to strengthen local government financing unit management. Financial institutions should actually step up risk identification and management, strictly observe borrower admittance conditions and perform review and approval procedures according to commercial principles. Illegal loan guarantee practice of local governments should firmly be banned. Meanwhile, it is necessary to research and establish a standardized borrowing and financing mechanism for local governments.

In terms of the way to address the hidden local government debt issue, Jia said that the key is how to turn "hidden rules" for local government financing practice into "transparent rules." Local government financing practice should become transparent so that it should properly dispose existing local government debt and move to avoid new ill local government financing practice.

He stressed the necessity of establishing a transparent local government financing system. The suggestions put forward by audit departments have already incorporated such contents, including the establishment of a local government bond system and the revisions to related laws and regulations. It is proposed that local governments may issue municipal government bonds that are matched with local projects so as to make local government debt transparent, under public supervision and subject to other types of supervisory systems.

In terms of local government debt management and repayment, Liu Shangxi, deputy director of the Research Institute for Fiscal Science under the Ministry of Finance, said that local governments should not only establish an overall local government debt management framework to classify, monitor and analyze various classes of local government debt but also clarify and define the relationship between financing platforms and local governments.

Ma Guangyuan, a member of the Chinese Academy of Social Sciences, said that to eliminate China's local government debt risk, it should resolve the institutional problems related to the tax sharing system as soon as possible and reduce local governments' reliance on land use rights sales. Local governments' excessive reliance on the revenue from land use rights sales exposes that local economies cannot generate enough revenue from their real economic sectors or small and medium-sized enterprises and can only live on land use rights sales. This evidently is a vicious circle.

This article appears in print on Page 02 of the July 8, 2011 edition of People's Daily Overseas Edition, translated by People's Daily Online
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