Local government debt out of control in China

Published Tuesday 8th December, 2015 23:00 HKT

“It’s all under control” said Finance Minister Lou Jiwei in late August, in a report to the Standing Committee of the National People’s Congress, regarding the total level of local government debt in China. The same was reiterated by Professor Wen Laicheng at Beijing’s Central University of Finance and Economics, and well by just about every Chinese media outlet that’s allowed to report on the topic.

The confidence levels are amazing considering how little information on the state of local finances are revealed to the public, particularly regarding individual provinces. Whilst at a national level, Lou assures us that debt ratios will not exceed 86%, recent local data points to trouble in the provinces.

China’s 21st Century Business Herald compiled more granular data from provincial NPC announcements and media reports, with chiecon first to report the news in English.

Lou’s report reveals that local government debt totalled Rmb15.4tn at the end of 2014, a 41.54% increase since the end of June 2013, the last time figures were revealed in public. The Ministry of Finance conducted another audit in October 2014, with the results due to be released on January 5th this year, although these have yet to be published.

Regardless, the lack of transparency fails to hide the Chinese government’s failure to deleverage local finances, a key economic objective for the new Xi Jinping led administration.

On August 29th, the NPC approved a State Council plan to cap local government debt to Rmb16tn for 2015. Since then, ten provinces or major cities have revealed their end of year local debt limits for NPC approval. Assuming the publicly announced debt limits are the same as actual debt levels (will be close at least), it is possible to see how some regions have fared since 2013’s audit.

As the following graph shows, for some of the regions published so far…not so well.

  
Left hand side shows the debt limit in place for year end 2015. Right hand side in red, the estimated debt ratio for 2015, which is the proportion of debt limit in comparison to the financial resources available. Right hand side grey shows the percentage change in outstanding debt from end of June 2013 to the debt limit announced for end of 2015.

Other than Chongqing and Hubei, the other provinces have all increased their debt levels since 2013. Despite the new administration’s promises to curtail excess local debt soon after taking office, in the case of Ningxia, a poor province in west China, local government debt has actually doubled! (Rmb50.2bn to Rmb113.9bn)

In order to keep risk under control, central policy makers have set 100% as the limit that local government debt ratios must not pass. Based on the debt limits published so far, Guizhou, Ningxia and Shaanxi have already exceeded the limit.

In fact Guizhou, a poor province in southern China, has a debt ratio of a whopping 207.73%, with total outstanding debt nearing Rmb1tn, a considerable amount for this relatively small economy. Ningxia and Shaanxi are around 111%, whilst Zhejiang and Hubei are at risk of breaching the 100% threshold.

At the national level, the increase in local government debt has slowed this year, climbing around half a trillion yuan, roughly a 20 billion yuan increase for each province. In other words, most of the gains occurred from mid 2013 to the end of 2014.

According to Professor Wen, this is because during the late 2014 audit, many local government finance vehicle debts were reclassified as local government debt, mainly due to the low repayment capacity of LGFVs. (Because many used borrowed funds to invest in low return or long term return projects, see this previous chiecon post). 

Recommendations for dealing with regions facing high local debt include increasing central to local fiscal transfers, proper handling of assets, and attracting private capital ( i.e. the PPP model).

The problem is, many local governments are experiencing a fall in income due to declining land sale and tax revenues, which puts further pressure on local debt ratios. With the macroeconomic growth also slowing, the Chinese government needs find other solutions to hit its targets in this year’s ‘Government Work Report‘ to control debt and maintain stable economic growth.

By far the quickest solution is to implement the local debt swap program, whereby high-yielding local debt is swapped for cheaper municipal bonds. This year’s quota has been set at 4 trillion yuan, although some overseas media reports indicate this might be expanded to 15 trillion yuan.

Lou said during this year’s Boao Forum for Asia that those local governments with high debt ratios, will be able to obtain a relatively higher debt for bond exchange quota, however any new debt issuance on top of that, would be limited.

Foreign investors should pay closer attention to the regional variations in debt levels, either from a risk point of view, or taking a contrarian approach, that it might mean some local governments would be more open to public-private partnership projects. (This post looks at other regional economic disparities in China).

Unfortunately for local Chinese residents in high debt areas, the local government’s waste of resources through inefficiency and corruption, and the need to channel more and more funds just to repay off old debt, equates to future investment in improving local services…denied.

(Article not to be reproduced without permission. Please kindly inform the site of any citations).

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