Wed, Jul 06, 2011 page1

• Ratings agency says China debt was understated

  DEFAULT RISK: Half the loans date from the 2008 financial crisis, when a huge stimulus package was unveiled, and they could destabilize the economy

  • Reuters, BEIJING
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  China’s local government debt may be 3.5 trillion yuan (US$540 billion) larger than auditors estimated, potentially putting banks on the hook for deeper losses that could threaten their credit ratings, Moody’s said yesterday.

  Moody’s reviewed a report released by China’s state auditor last week, which found that local governments had chalked up 10.7 trillion yuan of debt. Moody’s said it identified more loans funded by banks after accounting for discrepancies in figures given by various Chinese authorities.

  Investors worry the pile of loans, about half of which were racked up during a 2008 stimulus spending binge, could destabilize the Chinese economy in the long run. If banks have to absorb heavy losses, it could restrict lending.

  “We assume that the majority of loans to local governments are of good quality, but based on our assessment of the loan classifications and risk characteristics ... we conclude that banks’ exposure to local government borrowers is greater than we anticipated,” Moody’s analyst Yvonne Zhang said.

  The ratings agency said a jump in local government loan defaults could push the non-performing loan ratio for Chinese banks as high as 12 percent, well above its base-case scenario that envisions losses in the range of 5 percent to 8 percent.

  Unless China comes up with a “clear master plan” to clean up the problem, the credit outlook for Chinese banks could turn negative, Moody’s said.

  The agency said it expected Beijing to “implement gradual discipline” over the stock of government debt and that would involve the Chinese government leaving banks to manage a part of problem loans on their own.

  Many investors have long eyed China’s mountain of local government debt as a major risk. The worry is that slower growth in the world’s second-biggest economy could set off a wave of loan defaults and hobble its banking system.

  About half of the debt dates back to the 2008 financial crisis when Beijing unveiled a 4 trillion yuan fiscal stimulus package that compelled local authorities to spend their way back to economic health.

  However, the legacy of the massive spending is now catching up with China as maturity dates for the loans, many of which are due in 2013, draw closer.

  While most loans were used to build roads and other infrastructure that some analysts say China needs, it has also generated some wasteful spending.

  For the most part, investors have assumed that cash-rich Beijing would step in to soak up losses if needed, but some analysts are starting to flag the chance of banks paying for a part, or even all, of the losses.

  “There is political risk here and concern of a tail-risk event. While the likelihood is very slim, the risk here is that the central government steps away from these loans,” said Mike Werner, a bank analyst at Bernstein Research in Hong Kong.

  Some analysts said local governments still have options available for ensuring the debts don’t go bad, such as selling assets or extending loan maturity dates.

  Moody’s said it derived the additional 3.5 trillion yuan of debt after comparing the estimate of China’s state auditor with that of the bank regulator.
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