In China, Worries Over Municipal Debts

The Chinese government has begun a series of investigations of how much debt was incurred by local governments last year as part of economic stimulus programs undertaken in response to the global financial downturn.

Few experts expect anything like the European debt crisis to afflict China. The national government has very little debt by international measures and ample capacity to bail out local governments and banks that lent to them.

Eriko Koga | The Image Bank | Getty Images Flag of the People's Republic of China

But any potential rise in defaults by local governments that require assistance from Beijing could add to the central government’s liabilities, leaving less room for the government to spend money as the Chinese population ages. China has barely begun to set up a national pension system and faces growing demands to provide more medical care.

The announcement of the investigations Thursday came a few days after the top Chinese auditor warned that mounting local government debt could undermine the recovery in some parts of the country.

Liu Jiayi, head of the National Audit Office, said in a report to the Chinese Congress in the past week that borrowing by local governments had created public debt burdens totaling hundreds of billions of renminbi. The report questions whether those governments had the resources to pay down the loans.

The warning is the latest indication that a portion of the government-backed loans and money from a national stimulus package of 4 trillion renminbi, or $585 billion, could eventually be categorized as bad loans.

Much of that money went to huge local infrastructure projects that are now being scrutinized by the national government. Less than two weeks ago, the State Council, or the Chinese cabinet, ordered state banks and local governments to clean up the way they financed such projects. The council said many projects were being financed through quasi-independent companies that were sometimes being created to subvert restrictions on lending to local governments.

It is unclear how serious a threat local government debt is to the Chinese economy. Some economists say Chinese public debt is tiny in comparison with that of the United States and Europe and that worries that record bank lending last year could turn into mountains of bad debt are exaggerated.

Nicholas Lardy, an economist at the Peterson Institute for International Economics in Washington, said in a column in the past week in The Wall Street Journal that many of the worries were misplaced. He said that China had been smart to invest in infrastructure projects last year and that if debts mounted, local governments could service the debt by raising fees on water and subways.

But Fitch Ratings, the credit rating agency, warned in a report in the past week that record loan growth and aggressive efforts by state-run banks to repackage and sell debt to investors had raised credit risks in the country and could “lead to another financial crisis.”

In a release issued Wednesday by Fitch, Charlene Chu, the firm’s senior director for financial institutions in China, said that the financial positions of Chinese banks were more strained than they appeared to be and that “future asset quality deterioration is a near certainty.”

Victor Shih, an associate professor of political science at Northwestern University and a China specialist, said in an interview Friday that the new information released by the National Audit Office was disturbing. Professor Shih said that according to his estimates, investment companies backed by local governments may have had as much as $1.6 trillion in debt at the end of last year and that the debt could weigh on government banks.“The local-government debt problem is much bigger than the government is willing to acknowledge,” he said.

Keith Bradsher reported from Beijing.

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