China released a comprehensive review of the massive debt of its local governments yesterday and curtailed their future borrowing, taking its first major step to prevent widespread defaults from destabilizing its vast economy.
Releasing its first audit of local government debt, which amounts to 27 percent of the economy, China’s chief state auditor Liu Jiayi (劉家義) said local government financing vehicles would be cleaned up and regulated depending on the type of debt they hold.
The results, presented to the Chinese parliament by Liu, showed local governments had chalked up about 10.7 trillion yuan (US$1.65 trillion) of debt as of the end of last year.
The audit and the proposed measures, the most comprehensive so far, underscored Beijing’s determination to head off credit risks that may destabilize growth in the world’s second-largest economy ahead of a leadership change next year.
The audit office said about half of local government debt, or 4.97 trillion yuan, was held by financing vehicles, well under market estimates for the vehicles to have borrowed 10 trillion yuan.
Analysts welcomed the surprisingly low estimate for debt incurred by these vehicles, but many warned against reading too much into what may well be an understated figure.
Different definitions for what makes a financing vehicle, and a recent consolidation in the sector in the face of tighter regulation by Beijing have skewed the picture, they said.
“The lower-than-expected figure should alleviate some worries on a surge of new crop of bad loans in the banking system,” said Li Xunlei (李迅雷), an economist at Guotai Junan Securities (國泰君安證券) in Shanghai. “But we need to note that the way of calculating the debt varies from one ministry to the next.”
Yesterday’s release of the audit findings confirms a story last month when sources said Beijing wanted to start overhauling its local government debt mess by this month to have the house in order by the next leadership reshuffle late next year.
To clean up the debt mess, the sources said Beijing would shift 2 trillion yuan to 3 trillion yuan of debt off the books of local governments. They said Beijing and China’s big four banks will be forced to take some losses on bad debt.
Liu said efforts would be made to “clean up and regulate” financing vehicles and that “the borrower must bear responsibility.”
However, analysts thought any losses that Chinese banks may suffer would be manageable.
“These are among the best-capitalized banks in the world. Disaster isn’t going to happen, not this year, not next year,” said James Antos of Mizuho Securities Asia.
All said, few see a widespread banking fallout as they believe cash-rich Beijing will step in to absorb losses if needed.
As the owner of $3.05 trillion of foreign exchange reserves, the world’s largest, Beijing has deep pockets to recapitalize its banks.
And despite the eye-watering amount of debt that has been incurred by local governments, China’s total government debt stands at 44 percent of its GDP, well under the debt-to-GDP ratio of other major economies.
Japan’s ratio is more than 225 percent, while the US ratio is 93 percent and Germany’s is 75 percent.