In China, this proportion of fixed, illiquid assets exceeds 90 percent. Resource assets account for about 50 percent of total government assets, with operating assets amounting to 39 percent and administrative assets comprising another 6 percent.
The latter two are difficult to liquidate. Given that resource assets are scarce and non-renewable, the traditional practice of auctioning and leasing land to keep the fiscal deficit under control is unsustainable — especially at a time when external shocks or a domestic economic downturn could easily trigger a short-term solvency crisis or debt default. While fiscal revenues are on the rise, they account for only about 6 percent of China’s total assets — and their growth rate is slowing.
China faces additional debt risks from contingent liabilities and inter-departmental risk conversion, especially in the form of implicit guarantees on debts incurred by local governments and state-owned enterprises. Such guarantees constitute the most significant medium and long-term financial risks to China.
In recent months, there has been a surge in LGIV bond issuance, aimed at supporting local governments’ efforts to stabilize economic growth through stimulus-style investment projects. However, the implicit guarantees on these bonds amount to hidden extra-budgetary liabilities for the central government.
Local governments have also accumulated massive amounts of non-explicit debt through arrears, credits and guarantees. Once this debt’s cumulative risk exceeds a local government’s financial capacity, the central government is forced to assume responsibility for servicing it, directly endangering its own financial capacity.
At the same time, China’s corporate sector relies excessively on debt financing, rather than equity. China’s non-financial corporate debt accounts for about 62 percent of total debt — 30 to 40 percent higher than in other countries. Many of these heavily indebted enterprises are state-owned and have borrowed from state-controlled banks. The implicit guarantees on this debt also suggest that the government’s liabilities are much higher than its balance sheet indicates.
China is not too big to fail. In a fragile economic environment, policymakers cannot afford to allow the size of China’s balance sheet to distract them from the underlying structural risks and contingent liabilities that threaten its financial stability.
Zhang Monan is a fellow of the China Information Center, a fellow of the China Foundation for International Studies and a researcher at the China Macroeconomic Research Platform.
Copyright: Project Syndicate