Beijing is quite distressed these days, as huge local government debt is like an albatross hanging around its neck.
Having indulged in the illusion of being “the savior of the world” for more than two years, the Chinese authorities are now waking up to a long concealed plight in the country’s banking system. Just when the China Banking Regulatory Commission announced its determination to control loan risks in local financing platforms, the Ministry of Railways financials, which are notorious for being entangled with those of local governments, were discovered to be closing in on an unacceptable debt to net worth ratio.
Going Through the Roof?
The so-called “local financing platforms” refer to investment companies set up by local governments to borrow money from banks. According to the latest official statistics, as of year-end 2010, over 10,000 local financing platforms had accumulated 10.7 trillion yuan (US$1.7 trillion) in debt, about 30 percent of China’s total GDP. About two to three trillion yuan (US $309 billion to $464 billion) in loans most likely will default, without any way to collect on it.
GDP is the market or monetary value of total goods and services produced in a country during a given year. GDP includes all private (consumer) and public (government) sector spending, including export value minus import value, and investments.
An increase in GDP represents economic growth and a decrease in GDP results in a recession. Any prolonged decrease of the GDP due to an excessive number of business bankruptcies and protracted unemployment results in depression.
Under the Microscope
There are three significant problems with the local government debt.
First, the economic efficiency of these loans is miniscule. No more than 35 percent of the investments are likely to yield a payback, while the rest was wasted on unprofitable or failing projects or due to corruption. The former railway official Zhang Shuguang, for example, deposited US$2.8 billion in U.S. and Swiss bank accounts. Zhang’s family owns three luxury homes in Los Angeles.
Second, most of the loans guaranteed by local governments are unsecured, that is, they are without any financial security, lien or some other type of asset. These loans were guaranteed with government revenue instead of real assets, but many loans far exceeded the local governments’ ability to make good on any default. Since former Premier Zhu Rongji’s tax reform, local governments have had less financial power, but larger responsibilities, and many local governments are deep in debt. This year’s drop in housing and land prices has further weakened the local government’s ability to repay any debts since land sales and real estate-related incomes have become the pillars of local revenues.
Third, the political system makes it easy for the financing platforms to default. In order to reach the GDP growth goal, the Chinese government has been covering existing bubbles with new bubbles. Such policies gave rise to local governments forming unprecedented numbers of financing platforms. In addition, Chinese banks build their profitability on interest margins, which increase with the amount of loans handed out. Therefore, whenever possible, banks try their best to compete for borrowers. They eagerly targeted local government financing platforms for quick loan issuance.
What’s Bugging Beijing?
As the local governments rely on state-owned banks for local investments and economic development, the current financing model is a return to the planned-economy system. Beijing is concerned that such a model would incur large amounts of bad debt and eventually bring about a financial crisis.
There are two possibilities by which Beijing could clean up the local debt crisis: The first is that local governments will lobby the central government into relaxing its tight monetary policy and macro control. This will allow housing prices to shoot up again, and worsen inflation. The result is beyond imagination. The second possibility is to clean up local government debt by transferring the debt to some newly established companies.
However, Beijing appears to be choosing neither of these options. A Reuters report suggested that China plans to shift 2-3 trillion yuan debt off the books of local governments, and allow local governments to issue bonds. This is a way to launder the debt instead of solving the fundamental problem.Even worse, the local government bonds will transfer the debt to the bond buyers. Local governments are very likely to set the bond interest high in order to lure people to purchase the bonds. Next, banks transfer the individual’s deposits to local government coffers and thus cause a currency deficiency. These measures will not resolve the high risks of local government financing.
He Qinglian is a prominent Chinese author and economist. Currently based in the U.S., she authored “China’s Pitfalls,” which concerns corruption in China’s economic reform of the 1990s, and “The Fog of Censorship: Media Control in China,” which addresses the manipulation and restriction of the press. She regularly writes on contemporary Chinese social and economic issues.
Read the original Chinese article.