The audit of China’s local government debt paints a reasonably reassuring picture. The question is how complete that picture is.
The National Audit Office put the debt at 10.7 trillion yuan ($1.7 trillion) at the end of 2010. That is 27% of GDP, far lower than the worst expectations (this is the first time the numbers have been made public). It is also much higher than the central government’s debt of 17% of GDP. Add in all the usual liabilities that goes into a country’s public debt number and China is looking at an overall number of 80-90% of GDP, not particularly high by international standards but in such a state-centric economy, it will all come back to central government one way or another.
Much of Beijing’s stimulus package in response to the 2008 global financial crisis flowed through local government spending on public works. Local government debt rose by 62% in 2009 over the previous year, as local authorities laded up with bank debt (and the banks, state owned, with potential bad debt). The borrowing increased by a further 19% in 2010.
It also encouraged the widespread use of special investment vehicles to get round restrictions on borrowing. The audit says that there were 6,576 such vehicles, with a combined debt of $5 trillion. Yet this shadow financing system is only partially accounted for by the audit. Only loans explicitly guaranteed by local governments has been included. Beijing is already reported to be planning to shore up local government finances with a 2 trillion-3 trillion bailout to cover the 23% of the lending to projects with neither collateral nor viable cash-flow to cover their debt service (this bailout could include some securitization of loans for resale to private investors or through the bond market). In addition, the central bank has told banks to increase their capital reserves against similar projects that are only generating sufficient cash flow to service part of their debt.
The situation seems manageable for now, though central policy makers’ concern remains acute as they work on defusing the debt bomb. Most local-government debt has long maturities and fiscal and land revenues have been strong, even if land sale revenues are now softening. The risk of a local government debt default remains low–as long as economic growth remains brisk and the state-owned banks can be made to absorb some of the worst bad debts. The tick-tock of the debt bomb may be getting a bit less audible but it is still there.