Tough year ahead as huge debt falls due

Local government lending remains a thorny problem but municipal bonds will lend transparency

Local government debt has been regarded as a major risk for the Chinese economy, but official figures on exactly how much is owed have been difficult to come by.

Last year the debt was finally totted up, and the National Audit Office said it amounted to 17.89 trillion yuan ($2.93 trillion, 2.15 trillion euros) at the end of June, 67 percent higher than in 2010.

However, that is lower than the market expected, and shows that debt is essentially under control. But when you break down the figures, the risk of a partial financial crisis cannot be ruled out.

For a start, the debt ratios of the smaller local governments are too high, with 195 counties and 3,465 towns having ratios of more than 100 percent at the end of 2012; internationally, 60 percent is regarded as acceptable. About 10 percent of local governments are repaying 20 percent of their debt that is due by issuing new debt.

That shows that a spillover effect has been emerging, with smaller governments bearing the brunt of the consequences from the borrowing spree since 2008.

This year will be a particularly tough one for local governments, because almost 22 percent of all outstanding debts are due to be repaid.

Given that lower-level governments in the country's central and western regions are financially weak with poor debt management, they are most exposed to default.

The good news is that the central government's tolerance toward local debt is growing, signaling a break from its earlier tough stance.

If the central government feels local debt is getting out of control, it would probably issue a warning. But now that it thinks overall debt is controllable, it will ease pressure and, rather than crack down on debt growth, will move to debt system reforms.

In doing so, it will want to keep the debt market stable so reform measures can be carried out smoothly. Then, should an individual default case pop up, it could try a bailout to avoid shaking confidence in the market.

This thinking can be seen in two recent developments. First, the central government may allow city governments to issue municipal bonds independently as early as March.

It had piloted this practice but finally decided that the Ministry of Finance was responsible for issuing payment of local government bonds.

If those rights are now delegated to local governments, it means central government is giving them the green light to use municipal bonds to relieve the pressure of their earlier debts.

The move also shows that the central government wants local debts to be issued more openly. Compared with local government financing vehicles, municipal bonds are operated more openly and are subject to better supervision by the central authorities.

By allowing local governments to issue municipal bonds, the central government is in fact doing a tradoff: trading bond-issuance rights for transparency in local debts.

The second move that reflects the central government's tolerance toward local debt is the National Development and Reform Commission's announcement on Dec 31 that it would allow bond swaps in an effort to avoid defaults among local government financing vehicles.

The commission said that as part of its latest debt-restructuring effort, it would let local government financing vehicles issue new bonds to replace old ones that may have matured but cannot now be repaid because of a lack of funds.

Clearly, this shows the central government allowing local authorities to apply delaying tactics to avoid default.

From this, one conclusion can be drawn: China's property prices will remain stable if not robust.

Local government debt is closely linked to the property market, as governments, banks and trust funds often use land revenue and real estate as guarantees. The National Audit Office says 40 percent of local debt is backed by land revenue. Other studies have suggested banks have 60 percent of their loans backed by properties.

As the central government has shifted from cracking down on local debt to restructuring it, this should prevent the property market declining. If not, local governments will be unable to repay their debts.

The authors are analysts at Shanghai-based Universal Consultancy. The views do not necessarily reflect those of China Daily.