China’s Worrisome Economic Issues (2) – Local Government Debts

精英理财Aurora

While all the other countries have been loading up on debt like at all you can eat buffet, China seemingly has been prudently fasting, with a central government debt to GDP ratio of just 15% in 2012. But a comprehensive accounting would include the local government debts and a few other government obligations, which will amount to 72% of GDP. Even though this number is still lower than most developed nations, the threat is not so much the current amount of debt as the fact that it continues to grow so quickly. The local government debt ratios have doubled over the past six years to 40% of GDP.

How have local government managed to create such feat? It’s the product of several malfunctioned systems. A legal loophole allows local governments to create third party corporations called local government financing vehicles (LGFVs). In turn, these LGFVs are able to borrow from banks, WMPs. Local governments have spending obligations that far exceed their access to tax revenues. The remaining gap has been funded with debts. Lastly in 2008 central government undertook a huge stimulus program, which made banks lend to local governments and local governments engage in massive infrastructure investments. In return local government debts spiked. This local government debts problem become even more prominent as China’s housing market wobbles. Of the limited revenue that local governments are able to generate, land sale and construction projects are a disproportionately large source.

A massive amount of local government debt had been set to mature in late 2012 was forcibly refinanced by the central government, pushing its maturity back to at least 2016. The central government implicitly backs local governments. If local government were to default, central government will by default step in. Currently Chinese government holds currency reserve worth around US $3 trillion, or 40% of GDP, enough to eliminate all local government debts. But there will be a limit on how much more can central government take on.