Hard landing expected if local govt debt rises

If local government debt continues to rise over the next three-to-five years in China, the world's second largest economy will suffer a hard landing, Citigroup economists said Monday at a media briefing in Beijing.

"China's economy is facing downward pressure," Shen Minggao, chief China economist at Citigroup, said at the briefing.

Citigroup has adjusted its forecast for China's GDP growth in 2013 to 7.6 percent, down from 7.8 percent earlier this year, and growth is expected to further slow down to 7.3 percent in 2014, Shen said.

Other financial institutions including HSBC and Barclays Capital have also recently lowered their forecasts for China's growth in 2013.

The country's economic growth has been reliant on high leverage or massive debt to push for investment, and economic growth will inevitably slow down amid the overall trend of de-leveraging or constraining the debt level, according to Shen.

As China tries to change its export and investment-driven growth model to a consumption-driven model, its economic growth is experiencing a cyclical slowdown, according to Willem Buiter, global chief economist at Citigroup.

Excessive credit growth and a high level of debts have created financial vulnerability and a real challenge for policymakers, Buiter said.

Currently local government debt is controllable, Shen said.

The next three-to-five-year period is a very important time frame, he noted.

If China cannot tackle the problem of high local government debt over the next three-to-five years, and keep it at a reasonable level, it is likely that a crisis will break out in the future, he said.

Total local government debt in China is estimated to have hit 12.1 trillion yuan ($1.96 trillion) by the end of 2012, up from 10.7 trillion at the end of 2010, according to Moody's Investors Service.

The Ministry of Finance issued a batch of local government bonds worth 42.2 billion yuan on June 14, with one-third of the money raised through the issuance reportedly intended to repay some local government debt.

Local governments continue to borrow at low cost as they are backed by government credit, but due to the high level of debts, the investment efficiency is declining as new debts are being used to pay old debts, Shen said.

Policymakers realize the credit has been excessive and that the high debt model is not sustainable, so they have launched some reforms, said Liu Xiao, a macroeconomic analyst at Anbound Consulting.

However, long-term reform cannot address short-term problems such as the piling-up of debts, Liu told the Global Times Monday. Liu suggested that policymakers should tolerate the economic slowdown.