China Averts Local Government Defaults

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Chinese banks have rolled over at least three-quarters of all loans to local governments that were due to mature by the end of 2012, an indication of the immense challenge facing China in working down its debt load.

Local governments borrowed heavily from banks to fuel China's stimulus program during the global financial crisis and are now struggling to generate the revenue to pay them back, a shortfall that could cast a shadow over Chinese economic growth.

Banks extended at least Rmb3 trillion ($482 billion) – and perhaps more – of the roughly Rmb4 trillion in loans plus interest that local governments were to have paid them by the end of last year, according to Financial Times calculations based on official data.

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The calculations are imprecise because the Chinese bank regulator only announces figures for total outstanding loans to local governments, and does not publish details about interest payments or refinancing arrangements.

Nevertheless, three separate economists said the numbers confirmed that Chinese banks had implemented rollovers on a massive scale to stave off defaults.

"That's a correct observation and explanation," said Stanley Li, a banking analyst with Mirae Asset Securities. "Based on the payback period for the infrastructure projects [started by local governments], it will take more than 10 years to pay these loans back."

Huang Yiping, an economist with Barclays, agreed: "Rollovers were really the only option available to the government and to the banks. What can you do when three-year bank loans mature while the highway is still being built?"

Ken Peng with BNP Paribas said: "Rollovers have been the common practice and this is an indication of that."

Concerns about China's indebtedness have faded in recent months as the economy has rebounded, but many analysts expect growth to slow again later this year, a potential trigger for renewed worries.

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Shang Fulin, China's top bank regulator, said total outstanding loans to local governments were Rmb9.2 trillion at the end of 2012, according to reports in local media on Tuesday. At the end of 2010 such loans had reached Rmb9.1 trillion.

In the intervening two years, 41 per cent of all local government debts had been scheduled to mature, according to the national audit office. Moreover, Beijing had effectively blocked all new lending to local governments.

The implication of a stable outstanding loan volume is that the vast majority of local government loans that were to come due over the past two years have simply been extended. Accounting for interest payments of 6 per cent a year, local governments have paid back a maximum of about Rmb1 trillion.

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Stabilizing the level of local government borrowing from banks has been touted by the Chinese government as an achievement. "The government debt level is under control, and is safe," Wen Jiabao, the outgoing premier, said at the national parliament last year.

He added at the time that most of the existing debt was backed by "high-quality assets with stable cash flows and promising returns", and that the money would be gradually paid back.

With banks all but refusing to lend to local governments, cities and provinces have turned in increasing numbers to non-bank financial institutions, especially trust companies, and to the bond market to raise new debt.

"As the regulators have gotten more careful, they have been able to shift the risk to other sources of financing such as trusts and bonds," Mr Peng said. "The risk has not gone away. It's just been spread."

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Official public debt in China is extremely low, at less than 20 per cent of gross domestic product. But Mr Huang said Beijing might eventually have to pick up the tab for the local governments' debt – about 25 per cent of GDP – since it had directed them to spend the money in the first place.

"The ultimate responsibility will rest with the central government," he said.