Tuesday, 10 January 2012

Local govt loans threaten China’s financial system

Several provinces’ debt-to-GDP ratio tops national figure

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Guanyu 道 said...

Local govt loans threaten China’s financial system

Several provinces’ debt-to-GDP ratio tops national figure

09 January 2012

Local governments across China have borrowed billions of dollars to build bridges, shopping malls and apartments, leaving many insolvent and endangering the country’s financial system, analysts say.

While the central government in Beijing is in good financial shape - it has a relatively small budget deficit, a huge trade surplus and the world’s largest foreign exchange reserves - it is a different picture outside the capital.

Local governments had borrowed 10.7 trillion yuan (S$2.19 trillion) - 27 per cent of GDP - by late 2010, according to official data, though ratings agency Moody’s believes the figure is underestimated by 3.5 trillion yuan.

Several provinces have since published reports showing their debt-to-gross domestic product (GDP) ratio was higher than the national figure. Moody’s believes that between eight and 10 per cent of loans made by Chinese banks will never be recouped.

‘Debt across the board is rising very quickly,’ weakening the banking system, said Michael Pettis, a specialist in Chinese financial markets at Peking University. ‘But any attempts to slow its growth results in a rapid reduction of investment and (economic) growth.’

China’s total public debt - including the central and local governments - stands at 68 per cent of GDP, well below Italy’s ratio of 120 per cent or Japan’s which stands at more than 200 per cent. But when it comes to local authorities the key concern is repayment.

To meet their commitments local governments need to generate income from land sales, which is fuelling unrest in the world’s second-largest economy as residents increasingly complain that land is being unlawfully seized.

Another source of income is from infrastructure projects, many of which are not profitable or legal.

Investment in highways, shopping malls and apartment buildings has been a key driver of the economy in recent years, especially since the 2008 global crisis when Beijing ordered banks to open the credit valves to spur activity.

‘Over the past couple of years, more than half of Chinese GDP has been generated by investment in fixed assets’ such as factories and roads, said Patrick Chovanec, an economics professor at Beijing’s Tsinghua University.

There are ‘things that make economic sense but are not commercially viable’ such as roads or hospitals which should have been funded by taxpayer money, he said.

An audit of local government debt in 2010 found that 530.9 billion yuan has been misused, including illegally diverted to property and the capital markets, and ‘fake’ investments, the National Audit Office said last week.

Ultimately if the loans cannot be repaid, the banks will have to be bailed out by Beijing, meaning the central bank will have to print money, which will in turn create inflation - already a major headache for policymakers.

A recent downturn in China’s housing market will also weigh on the finances of cities and provinces that had planned to pay off debt by selling land at high prices.

Such sales represent a major share of municipalities’ incomes - 48 per cent in the case of the southern city of Guangzhou in 2010, according to the China Business News.

As a result, the central government has sought to make local authority financing less dependent on real estate.