Repayment pressure, opaque financing highlight debt risks

Data released by China's top auditing authority this week unveiled multiple problems regarding local government debts, as mounting repayment pressure and indirect-financing have led to concerns whether the debts are under control.

The National Audit Office (NAO) has found liabilities worth 3.85 trillion yuan (624.61 billion U.S. dollars) owed by 36 local governments, including both provincial and municipal, by the end of 2012. The figure climbed 12.9 percent compared to the end of 2010.

China-based economists have voiced concerns about the country's debt situation.

Bai Jingming, deputy director at the Institute of Fiscal Policy with the Ministry of Finance, said that local governments need to be "highly vigilant" against fiscal and financial risks. Violations in local government borrowing will affect government solvency and amplify risks.

The NAO report warned that some local governments have turned to a more hidden way for financing, such as trust loans, financial leasing, and even illegal fund-raising. These are difficult to supervise and normally carry higher financing costs than banks' lending rates, and could trigger new risks.

Bai said problems like illegal financing change the purpose of the use of funds and the existence of idle funds need to be strictly controlled.

Of the 36 local governments audited, 11 provincial and 13 municipal have seen their total arrears rise compared to 2010, with some having to create new debts in order to pay old ones. A total of 14 municipal governments reported 18.17 billion yuan of debts that were overdue by the end of last year.

Lian Ping, chief economist at Bank of Communications, said that the pressure to repay debts is mounting, and is likely to see a repayment peak between 2013 and 2014.

Bai said that surging local government debt may build up pressure for price hikes and likely worsen the future solvency and raise costs for further investment.

However, the report was not all gloom and doom regarding the current debts situation. It cited stricter supervision and management of new debts and the use of the fund, and further streamlining the debt structure of local governments' financing vehicles (LGVs). The 233 LGVs audited saw their debt asset ratio drop by 4.16 percentage points compared to the end of 2010.

The economists hold the view that the scale of the nation's local government debt is generally "controllable". Lian said that the 12.9-percent rise of debts appeared to be moderate as compared to the rise of the country's total social financing, which surged more than 23 percent in 2012. Meanwhile, local governments have reaped good fiscal revenues, which grew 16.2 percent in 2012.

The report said that bank loans accounted for 78 percent of local government debts as of the end of 2012. However, the percentage had dropped by 5.6 points compared to the end of 2010, suggesting a more cautious attitude from banking institutions toward lending to the LGVs.

Local governments play a key role in China's fixed asset investment, accounting for more than 90 percent of the nation's total in 2012. This investment is the main reason for the surge in local government debt.

Bai suggested the local governments optimize their investment portfolio in accordance with the ongoing trend of economic restructuring stressing internal demand, and an emphasis on the efficient use of resources.

Lower-level governments should avoid blindly investing in saturated industries driven by the lure of high tax revenue, he added.