China faces up to the hidden debts of its local governments

Jun 2nd 2011 | HONG KONG | from the print edition

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BANKS in Western countries dragged their economies into the great recession. Banks in China pulled the country out of it. Much of the Chinese government’s stimulus effort from 2008 to 2010 was left to financial institutions, which proved better at shoving money out of the door than America’s federal government.

The banks lent to thousands of investment corporations set up by local governments, which cannot borrow in their own name. With the help of some initial capital and collateral, like land, these investment vehicles directed the lending into local bridges, tunnels and real-estate ventures. But many of the loans have turned bad, threatening the balance-sheets of the banks that made them.

The government has never revealed how much debt the local-government vehicles took on. Despite this opacity, or perhaps because of it, these hidden liabilities have become one of the four big worries haunting China-watchers, along with the property bubble, inflation and lightly regulated trust companies. Victor Shih of Northwestern University has described the debts as a “big rock-candy mountain”. In June 2010, he projected it might reach as high as 24 trillion yuan ($3.7 trillion) by the end of 2012, or over half of China’s GDP.

But the central government itself now reckons the debts amount to 10 trillion yuan, according to an official cited by Reuters—a quarter of GDP. That is bigger than America’s state and local-government debt (18%) but the same as India’s (25%).

Not all of this 10 trillion yuan will go bad. Some local-government investments will prove “bankable” in the strict sense that the borrower captures a big enough return to repay the loan. An analysis by the 21st Century Business Herald, a Chinese newspaper, suggests that only 28% of the loans have failed to generate much cashflow. In other cases, the social benefits of a project might exceed the costs, even though the benefits do not accrue to the local government itself—especially if the people employed would otherwise have stood idle.

But could China afford the stimulus? The official public debt of the central government was only 19% of GDP at the end of 2010. Adding the debts of local governments, the non-performing loans of the banks and other liabilities, such as central-bank bills, the public debt amounts to about 80% of GDP according to Andrew Batson and Janet Zhang of GaveKalDragonomics, a consultancy in Beijing. That sounds high for a developing country. But like India’s similar debt burden (73% of GDP), the liabilities are mostly denominated in the country’s own currency and held domestically, often by docile institutions, such as state banks. “The only entities that could trigger a crisis of confidence in government debt are themselves owned by the government,” they say. China’s public finances may not be as sweet as they appeared, but they are not sour.