After nearly three years, China finally updated its local government debt figures just before 2014 kicked in.
In a broad sense, local government debts amounted to 17.89 trillion yuan (US$2.93 trillion) as of the end of June 2013, according to the National Audit Office. That’s a 67 percent jump from 10.7 trillion yuan at the end of 2010, the last time the office released the debt data.
The latest debt levels are lower than market has expected, showing that debts are basically within control.
But if the figures are examined by breakdowns, the risk of a partial financial crisis cannot be totally ruled out.
To begin with, debt ratios at lower-level governments are too high, with 195 counties and 3,465 towns seeing ratios that exceed 100 percent by the end of 2012, much higher than the internationally accepted 60 percent.
This shows that a spillover effect has been emerging, with smaller governments bearing most of the consequences of the lending spree that started in 2008.
What’s more, 2014 will be a tough year for local governments, as nearly 22 percent of all outstanding debts are due to be repaid this year.
Given the fact that lower-level governments in the country’s central and western regions are financially weak and poor in debt management, they are the ones most likely to default.
But the good news is that the central government’s tolerance toward local debts is growing, signaling an easing of its previously tough stance.
If the central government feels local debts are running out of control, it would most likely serve some sort of warning.
But now that the central government feels that the overall debt risks are controllable, it will shift from cracking down on debt growth to reforming the debt system. During this process, it may want to keep the debt market stable so that reform measures can be carried out smoothly.
In this sense, if an individual default risk pops up, the government could undertake a bailout to avoid shaking up market confidence.
This thinking can be seen in two recent developments.
According to mainland media reports, the central government may allow city governments to issue municipal bonds on their own as early as March.
China had piloted the practice of allowing local governments to issue city bonds, but it later decided that the Ministry of Finance was responsible for the issuance and payment of local government bonds.
Now if those rights are delegated to local governments, it means that the central government is giving the green light for local authorities 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. Unlike local government financing vehicles (LGFV), whose operations are not so transparent, municipal bonds are operated more openly and can be subject to better supervision by the central authorities.
By allowing local governments to issue municipal bonds, the central government is actually doing a trade-off: it is giving up bond-issuance rights to ensure the transparency of local debts.
In another move that reflects the central government’s growing tolerance toward local debts, the National Development and Reform Commission said on Dec. 31 that it would allow bond swaps in an effort to fend off LGFV defaults.
The commission said that as part of its debt-restructuring efforts, it would let local government financing vehicles issue new bonds to replace old ones that may have matured but cannot be repaid as yet due to lack of funds.
In effect, the central government is allowing local authorities to resort to delaying tactics to avoid default.
One conclusion can be drawn from this situation: China’s property prices will remain stable, if not robust.
Governments, banks and trust funds often use land revenue and real estate as guarantees. According to the National Audit Office, 40 percent of local debts are backed by land revenue. Other studies suggest banks have 60 percent of their loans backed by properties. These figures clearly indicate a close relationship between local debts and the property market.
As such, the central government’s shift in approach from a crackdown to a restructuring of local debts would bolster the property market and prevent its collapse. Otherwise, local governments won’t be able to repay their debts.
– Contact the writer at [email protected]