‘Blue Monday’ should always be forecast for January, according to a psychologist commissioned to identify the most miserable day of the year. His formula looked at weather and debt, as well as depression brought about when people failed to keep New Year’s resolutions. His conclusion? That the third Monday of January is the most depressing of the entire calendar.
But for plenty of government finance officials in China, it was the final Monday in December that threatened to be their darkest day. That was the publication date of an audit ordered by the State Council into local governments that have splurged unsustainably on debt.
A particular problem for financial regulators is that they haven’t been sure how much local governments have borrowed via financing platforms (a practice WiC first referred to in issue 48). Hence the lengthy review by the National Audit Office (NAO) that looked through the books of more than 62,000 government departments and credit documents for more than 700,000 projects.
Many feared that the findings were going to be a lot worse. But most commentators have zeroed in on the new figure of Rmb17.9 trillion of local government liabilities (or almost $3 trillion in dollar terms), an increase of more than two-thirds on the Rmb10.7 trillion of borrowing estimated at the end of 2010.
Unsurprisingly, the official response downplayed the figures. Although the audit office acknowledged “potential risks in some places” – including the three provincial governments, 99 cities, 195 county administrations and 3,465 townships with direct debt amounting to more than 100% of yearly economic output – it insisted that debt levels were “under control” overall.
The auditors also included an additional category of borrower in the latest survey. That’s because the investigation was extended down to the township level for the first time (there are 30,000 of them in China, each responsible for populations of about 10,000). Take these out of the comparison and the increase in indebtedness slows.
As the Economist magazine has highlighted, the full estimate of Rmb17.9 trillion in debt includes three main types of liability. The lion’s share (Rmb10.9 trillion) stems from direct borrowing by local governments. But Rmb2.7 trillion comes from explicit guarantees made by the same entities, to be paid out only if the original borrower cannot meet its obligations, while a further Rmb4.3 trillion is guaranteed implicitly, meaning that local governments would probably feel compelled to step in financially in the worst-case scenario.
Most of the media has lumped all of these contingent liabilities into the headline total, the Economist noted, which assumes that all of the loans will sour. Yet this looks unlikely: the report’s footnotes say the government has been forced to bail out less than a fifth of these types of loan in the past. Of course, the proportion might go up in the months ahead. But if it stays close to earlier levels the expected burden shrinks to Rmb12 trillion or 22% of GDP.
The audit office also argues that total public debt (local government plus central government, direct plus contingent) remains at a manageable level. Jia Kang, head of a research institute funded by the finance ministry, agreed that the burden is “definitely in a safe zone”, while Qu Hongbin, HSBC’s Chief China Economist and one of the authors of a research piece on the topic this week, also felt that the position is “comfortable” relative to many developed economies. Qu estimated total government debt in China at a little over Rmb30 trillion or about 53% of last year’s GDP.
By comparison, Japan’s public debt is projected to hit more than 200% of GDP this year, while public debt in the United States stands at a little over 100%.
Despite this, there is recognition that borrowing has been rising too quickly (by about 20% a year since 2010) and at a level well above economic growth and increases in fiscal revenue. The audit found that the percentage of loans classed as overdue is now more than 10% of borrowings too, much higher than the 1.3% ratio in the banking system.
Simon Rabinovitch at the Financial Times sounded a further warning that the forecast overlooks corporate debt, which is high by international standards, surpassing 100% of GDP. But none of this shows up as contingent liability in the recent audit, he notes, even though Beijing tends to bail out local champions in financial distress.
A lot of the borrowing for longer-term projects like airports and railways has been made on repayment schedules of much shorter tenor, while the report also indicates that nearly 40% of current borrowing is going to mature by the end of this year. Many loans will have to be rolled over, which is already contributing to money market turbulence, following a frightening credit squeeze last June (see WiC199), another in the autumn, and a further flurry over the Christmas period when the seven-day repo rate – a benchmark of what banks pay to borrow from each other – rose to 9%, compared with averages of around 3% earlier in the year.
The Christmas crunch was partly due to seasonal factors as banks prepared for year-end and put aside cash to cope with customer withdrawals over the Chinese New Year at the end of January. But some Chinese lenders – especially smaller and middle-sized ones – have been relying on interbank borrowing to reduce the maturity mismatches between the longer-term assets they have funded and the shorter-term borrowing used to finance them.
Refinancing an ever-larger share of this debt will mean more strain for bank balance sheets, which is probably why Beijing is having a rethink on restrictions limiting most local governments from issuing their own bonds.
A statement from the National Development and Reform Commission last week confirmed the change of heart. “If construction projects face funding shortfalls and there is no way of completing the project to realise expected revenues, we will consider granting permission for these platform companies to issue an appropriate amount of new debt,” it acknowledged. “The funding that is raised can be used to ‘borrow new and repay old’ and for incomplete projects, ensuring that they will not end up half-finished.”
At least policymakers have other options available, says HSBC. Chinese government entities have Rmb78 trillion in net assets, some of which could be sold to meet debt repayments. But the more fundamental issue is that local officials can’t raise enough revenue to pay for the public works that they are expected to provide. According to the World Bank, they are currently responsible for 80% of public spending but only get about 40% of tax revenues. The result is that they are being forced into selling land or borrowing from banks to meet their obligations.
“Change – especially painful change – tends to be avoided or delayed until something very serious comes along to force it,” the HBSC research piece advised.
“For China’s unbalanced fiscal system, local government debt is likely to be the trigger.”
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