What strikes this Bystander as interesting about the World Bank’s latest quarterly update on China’s economy is not so much the 9.5% forecast of GDP growth for this year. A glance at any factory, wharf or store gives one an intuitive sense that the economy is outpacing last year’s 8.7% growth. All the Bank’s macro points — modest inflation risk, concern for real-estate bubble, need for more monetary tightening, correctness of fiscal neutrality, advisability of revaluing the currency — strike us as sound and unsurprising, too. What did catch our eye was the attention given to the strain on local government finances.
The central authorities have rightly increased vigilance over lending by local government investment platforms. Given China’s solid macroeconomic position, the local finance problems are unlikely to cause systemic stress. But the flow of new lending to the platforms needs to be contained and local government revenues need to become less dependent on land transaction revenues.
A huge amount of last year’ 9.6 trillion yuan of new bank-lending found its way into local government infrastructure projects. These are frequently done through captive commercial investment companies so provincial and municipal officials can get around the rudimentary system Beijing has for allocating tax revenues to provinces and cities for spending. The concern is that these investment getarounds, of which there are an estimated 3,000, won’t generate sufficient returns to pay operating and interest costs or to repay the loans taken on, leading to a rise in non-performing bank loans, especially at smaller (and weaker) regional and local banks, or leaving local governments holding the can.
The CBRC recently estimated that their bank debt increased by RMB 1.3 trillion in 2009 to RMB 5‐6 trillion at end 2009, with estimated additional committed lines of RMB 3 trillion. The possible total of RMB 9 trillion is equal to 27 percent of GDP, while some other estimates of the total liability are even higher. However, a large portion of this debt was accumulated before 2009 and so far no systemic problems have occurred as a result of it.
Even if, as the Bank repeatedly notes, the problems won’t rise to the level of a systemic risk to the banking system, Beijing has already spent trillions of yuan this decade in cleaning out the banks’ bad-loan books and doesn’t have any apetite to do so again. It wants to clean up and rein in local government debt growth before it becomes another bubble.
The PBC and the CBRC have both warned of potential problems and called on banks to strengthen risk assessment of lending to local government projects. Some individual banks subsequently announced increased vigilance towards this type of lending. The central government is apparently considering issuing new rules on local government guarantees, with suggestions that letters of guarantee or comfort will not be valid anymore.
Tighter administrative restrictions on circumnavigational financing through local governments’ investment units is being accompanied by giving provinces and municipalities more direct access to capital markets, including an experiment with a local-government bond market. The Bank encourages Beijing to go much further:
Reform of the intergovernmental fiscal system is needed to increase and diversify the revenue base of local governments, making it rely less on volatile land sale revenues. Moreover, local fiscal activity needs to become more transparent. It would be good to include land sale revenues and the infrastructure and urban development activity in local government budgets.
That, though, would be the work of more than one five-year plan.
Update: China Daily has an example of what can allegedly go wrong.