Policymakers can’t turn blind eye to debt dangers

By Qiu Chen Source:Global Times Published: 2014-1-2 21:08:05

Illustration: Lu Ting/GT

China's National Audit Office (NAO) released the results of its latest local government debt review Monday, five months after the accounting watchdog announced the launch of its sweeping nationwide investigation.

Overall, observers and investors have reacted favorably to the audit's findings. While experts, by and large, see the current risks as controllable, there are still several issues which require the attention of central financial authorities.

According to the NAO, China's provinces, cities, towns and counties owed a combined 17.9 trillion yuan ($2.96 trillion) to creditors as of the end of June - this figure includes money borrowed in various forms, such as contingent liabilities as well as debt guarantees.

Though the figure itself is high, it is below what many in the market had anticipated, a development which has soothed many of the more acute anxieties about local borrowing. Moreover, the vast majority of local loans were directed toward revenue-generating fixed assets and construction projects to further area development.

This audit - the most comprehensive analysis yet of nationwide debt in China - gives central planners an unprecedented amount of clarity on debt conditions in the country's localities. As top leaders craft policies designed to rein in reckless local borrowing, accurate data and statistics are of paramount importance. Local debt levels have long been shrouded behind a veil of uncertainty and guesswork, leaving plenty of room for investors to fret about the possibility of a ticking credit time bomb at the center of the world's second-largest economy.

Prior to this past audit, the NAO had published two reports concerning local government debt. The first one, in 2011, excluded township-level governments; while the second, in 2012, only covered 36 local governments.

Though the results of these two previous audits also suggested that China's debt risk is manageable, their lack of granularity only created new worries and concerns. Fear of the unknown led many investors and think tanks to adopt increasingly alarmist views concerning the country's debt risk. By the beginning of 2013, many even believed that a Chinese financial crisis was imminent. At the very least, the local credit situation was acknowledged as untenable and counterproductive to the financial health of China.

This latest NAO review will hopefully placate the market and end the endless speculation concerning debt levels. Moreover, this new degree of transparency only highlights the government's determination to cope with a phenomenon which has been haunting the country for years.

The bright spots, however, should not distract us from the potential dangers indicated by the report. Chinese authorities should, for instance, be alarmed by the rapid growth in leveraging seen across the country. As the NAO uncovered, China's accumulated local debt volume swelled by roughly 20 percent annually between 2010 and mid-2013. If local authorities cannot hit the brakes now, China could find itself under a sea of unpayable loans.

Over the short-term though, repayment pressures are likely to put the squeeze on many localities as well. According to the audit report, debts due from July 2013 to the end of 2014 account for 44.8 percent of the total loan volume. To keep their creditors at bay, localities may have to continue borrowing just to service their existing loans - an option recently opened by the National Development and Reform Commission.

As the NAO mentioned, overdue loans hit 1.15 trillion yuan by the end of their reporting period. Continuing this trend would not only ruin the credibility of local governments, it would also increase the possibility that the country's banks could swallow a potentially enormous quantity of bad loans.

In the face of such potential hazards, more transparency and accountability are needed to determine how much is being borrowed, who is borrowing and who is responsible for repayment. Local authorities should be held accountable for debts accrued under their watch. If administrators know they can always escape punishment by changing their positions or requesting a central transfer, a slowdown in borrowing is unlikely.

At the same time, the central government should come up with policies to lower local authorities' incentives to borrow. For instance, cadre evaluations should focus less on GDP growth and infrastructure construction. In the past, officials have been known to pursue poorly conceived projects as a way to bolster their development records right before upcoming reviews.

Reforms to China's tax system are needed as well. Currently, the lion's share of local tax revenue is funneled into central coffers, even though local governments are required to fund the bulk of public works projects and social services. Strained budgets have forced many local governments to establish financing companies designed to fill fiscal shortfalls.

The author is a reporter with the Global Times.


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