Guangdong Debt, Cooked Books and Pyramid Schemes

In the first five months of this year, the GDP of China’s southern Guangdong province grew by 12.9%, official data shows, while its industry’s electricity consumption fell by 0.1%. Either Guangdong businesses have made a remarkable breakthrough in energy efficiency, or somebody is cooking the books.

Provincial lawmakers think it is the latter. With unusual openness they have challenged the accuracy of the provincial government’s GDP numbers. At the same time they have questioned the province’s reliance on land sales for revenue to service its debt, causing it to borrow evermore to pay the interest on old debt, and tying itself to the cyclical fortunes of the real estate market.

It is this latter concern that that raises the larger red flag to this Bystander. If government finances in as prosperous and progressive a province as Guangdong are raising such concerns, how deep are the similar problems elsewhere?

The strain on Guangzhou’s purse is increasingly evident. Debt plus interest due this year will eat up 20% of the province’s estimated income for the year, a ratio that triggers alarm bells among lenders everywhere. The provincial government’s total debt to income ratio hit 100% as of end-June. Banks have become reluctant to lend to the province, even though in May central government told state banks to be accommodating in their lending standards where necessary.

Beijing has become increasingly jittery about the ticking time bomb of the country’s local government debt. Last month, it ordered a national audit to be conducted. The last time it conducted such an exercise, in 2010, it came up with a number equivalent to 27% of China’s GDP. Unofficial estimates put the ratio now at 40% of GDP. That translates to 20 trillion yuan, or $3.5 trillion of indebtedness.

It is also reaching the point of a pyramid. Local government borrowing, mostly to finance the infrastructure growth that powered decades of double-digit growth, and since the global financial crisis of 2008 to forestall a too-rapid slowing of that growth, has become unsustainable. Investment projects, often conducted through special investment vehicles (SIVs) to get round restrictions on direct local government borrowing, are not providing sufficient, and in many cases no returns to cover their cost of capital, typically a bank loan secured against anticipated land sales.

An IMF study published in April found that four out of five cities and two out of five counties had secured infrastructure financing against future land sales. We shall pass over the social stability risks involved in appropriating the land for such sales to note that provinces and municipalities are having to borrow anew to repay principal and interest on their existing debt. When confidence tricksters do it, it is called a pyramid scheme.

They tend to come tumbling down in the end. We don’t for a minute think Beijing would let matters get to that point. China has bailed out its big state owned banks before in the 1990s after they had had to bail out local governments. Older hands may remember the’ 90s version of SIVs, provinces’ international trust and investment corporations.

Beijing has the wherewithal to do so again if necessary. The political will to do so would quickly be marshaled in the face of the potential social unrest.

Meanwhile, China has been slowly moving towards establishing a muni-bond market to provide an alternative for provinces to bank borrowings. Capital markets have a Darwinian approach to credit worthiness which few local governments would survive as things now stand. Hence Beijing’s caution and issuance blessing for only those administrations that can muster an AA+ credit rating or better.

For its part, Guangdong plans to issue a record $12.1 billion yuan of bonds this year, a 40% increase on last year’s issuance. That, though, is as much a sign of the size of the problem as a solution.


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