Chinese risk: the truth behind China's massive local government debt.

Author:Lo, Chi

Debt crisis worries are not limited to Europe these days. China's local government debts are also creating jitters, especially after Moody's issued a report in July 2011, saying that China's official National Audit Office had under-reported local government debts by [yen] 3.5 trillion (US$538 billion) and that Chinese banks' non-performing loans could soar to 12-18 percent of total assets because of their heavy exposure to local government borrowing. This potential danger from Chinese debts seems to underscore China's problems of being an opaque system with hidden debts and rustic economic management policy.

Details of China's local government debts are still scanty, despite the National Audit Office's revelation. So any attempts to quantify the risk of these debts are risky themselves. Macro indicators argue that, at less than 60 percent of GDP, China total public debt (central and local government debt, plus local government financing vehicles) is within manageable limits. China's fiscal and public debt positions also compare favorably with other countries.

The true risks of the local government debts lie in the balance-sheet mismatch of their debt structure, with governments in the central and western regions having the highest risk as they have borrowed beyond their ability to repay. Local government financing vehicle debt risk cannot be ignored, but overall it is not imminent because the government has massive assets on its balance sheet and favorable debt dynamics on its side---namely a nominal interest rate significantly below the nominal GDP growth rate.

THE CONFUSION

The release of debt data for local governments and local government financing vehicles in early July has stirred confusion in the market, leading some to argue that China has massive hidden government liabilities that could blow up any time and crush the banking system. This perception owes much to the lack of consistent data reported by various Chinese government agencies.

The National Audit Office released its estimate of [yen] 10.7 trillion total outstanding local government and local government financing vehicle debts as of the end of 2010, with the latter accounting for 46.4 percent (or [yen] 4.97 trillion). Within this [yen] 10.7 trillion total, 79 percent or [yen] 8.5 trillion were in the form of bank loans. But in its regional report released before the National Audit Office report, the People's Bank of China reported that its estimate for the local government...

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