China alert to debt risk fears

BEIJING - Three years after a massive stimulus package kept China's economy moving during the global recession, policymakers and the market are now awakening to risks facing the world's second-largest economy.

With mounting local debt triggering widespread concerns among domestic investors and foreign rating agencies, the government has listed dissolving financial risks as an important task this year.

In an executive meeting held this week, the State Council, or China's cabinet, called for effective efforts to guard against risks in local government debt and credit markets while vowing to step up market oversight.

The China Banking Regulatory Commission (CBRC) also sounded an alarm for commercial lenders, warning that they should carefully watch loans extended to local government financing vehicles (LGFVs), which are financial entities set up by local governments to invest in infrastructure and other projects.

US rating firms Moody's and Fitch both lowered their credit ratings for China last week over concerns about the risks that rapidly surging local government borrowing has posed to the broader economy.

"Progress has been less than anticipated in making local government contingent liabilities more transparent and reining in rapid credit growth," Moody's said.

Authorities have tried to slow local government borrowing through LGFVs after reports showed that about 35 percent of debt owed by LGFVs is set to mature between 2012 and 2014, raising concerns that local governments may be unable to handle liquidity pressure amid a slowing economy.

MOUNTING LOCAL DEBT

Much of the local debt in China came from a surge in lending in the wake of the global financial crisis in 2008, when policymakers adopted a 4-trillion-yuan ($640 billion) stimulus package to buoy the economy.

Local governments took advantage of the borrowing and spending binge between 2009 and 2010 and owe a great deal of debt that has beset the government and the market.

Flooding the economy with trillions of yuan in new loans helped China maintain high economic growth and resist the global recession, but debt has run up rapidly in recent years.

Xiang Huaicheng, China's former finance minister, cited data from Barclays Capital at the Boao Forum held earlier this month stating that the central government borrowed about 7 to 8 trillion yuan, while local governments owe more than 20 trillion yuan in debt.

"The Barclays data are groundless," said Dong Dasheng, deputy auditor-general of the National Audit Office (NAO).

After three months of nationwide auditing by about 40,000 auditors, NAO announced in June 2011 that total local debt totaled 10.7 trillion yuan, which is far less than the figure given by Barclays.

Over 1.8 million debt records from 26,000 government departments and public institutions, 6,576 LGFVs and 373,000 projects were reviewed during the nationwide audit, according to the NAO.

Local debts include 6.71 trillion yuan directly owed by local governments, 2.34 trillion yuan borrowed by enterprises and public institutions and guaranteed by local governments and 1.66 trillion yuan owed by independent enterprises and public institutions that local governments have the responsibility of bailing out.

The NAO data revealed that as of the end of 2010, only 54 governments at the county level were debt-free, while debts owed by governments at provincial, city and county levels accounted for 29.96 percent, 43.51 percent and 26.53 percent of the total debt, respectively.

Of the total local debt, nearly half came from 11 provinces and municipalities in eastern regions, according to NAO.

Shang Fulin, the former chairman of CBRC, said in January 2013 that local governments' outstanding loans stood at 9.2 trillion yuan as of the end of 2012.

Local liabilities began surging in 1998 and 2009, when outstanding debt surged 48.2 percent and 61.9 percent, respectively, from the previous years against the backdrop of the Asian financial crisis and the global financial meltdown.

According to NAO, LGFVs have become the primary source of risks, owing about 70 percent of total local debt.

The mammoth local debt also poses a threat to the country's banking system, as bank loans account for about 79 percent of the debt.

RISK CONCERNS

"Solvency is now in focus and it doesn't matter much whether it's an LGFV or not," said Yang Kaisheng, president of the Industrial and Commercial Bank of China (ICBC), the country's largest lender.

Yang said ICBC has granted about 630 billion yuan in loans to LGFVs and 98 percent of them are without risk.

Banks were told by CBRC to act more strictly when lending to LGFVs, as well as pay special attention to LGFVs with high debt ratios.

Banks are now banned from extending credit to vehicles with debt-to-asset ratios over 80 percent.

"Even though we have many different data about the size of local government debt, I think the figures provided by the CBRC are more accurate," said Huang Zemin, director of the International Financial Research Institute at the Shanghai-based East China Normal University.

"What worries me is the debt owed by governments at the county level, as provincial governments have more revenues and assets to repay their debts," Huang said.

For county governments, Huang noted, "if they fail to continue financing when their previous debts mature, risks will break out. "

According to NAO data, 22 city governments and 20 county governments will have to rely on new loans to repay 20 percent of their old debts, while four city governments and 23 county governments have 10 percent of their debts overdue.

Dong said the LGFVs' exposure is controllable, but proper debt extension will greatly help dissolve risk.