Local Government Debts are not so dangerous now

In October last year, the book of the Study on the Problem of China’s Fiscal and Financial Risks released by the Development Research Center of the State Council indicated that up to the end of 2010, the total liabilities of the central government and local governments was 23.76 trillion yuan, occupying 59% of the whole GDP in 2010, approaching the world recognized warning line of government debt-to-GDP ratios. Such ratio raised anxieties of many people, and they screamed that there will be debt crisis in China soon.

Is it true? Some experts seem not so pessimistic. Why? There are three reasons.

First, this round of expansion of local debts is the result of bailout policies for global financial crisis in 2008: in 2009, the local debts boomed 61.92% comparing with that of 2008. In fact, this is not something new, but the convention for dealing with crises. The last round of the East Asia financial storm happened in 1997, and in the following year 1998, the local debts boomed 48.20%. That is to say, the local government debts may merge with the balance sheet of the central government. This leads all the warning and worries on local government debts to become insignificant.

Second, from the composition of the local debts, those debts that the governments have legal repayment responsibility occupy about more than 60%, and those debts that the government have joint guarantee occupy about less than 40%. Today, almost all the local government debt problems root in the latter one. This indicates that the seeming debt crisis correlates with central bank’s tight monetary policy now. Once the central bank easing the policy in the near future (and it is very likely), local governments’ debt burden will be greatly reduced, and they have enough time to seek new financing channel for repayment. As you can see, simply relying on the loosening of the monetary policy, the problem of local debts may be relieved, so it indicates that the local government debts problem is not so dangerous.

Finally, viewing from the repaying ability, there will be no insolvency cases for local governments. Under the current urbanization development patterns, urban lands go more and more expensive in China. As the ownership of all the urban lands belongs to the nation, local governments are wealthy enough to pay debts with their land reserve. From this perspective, Chinese local governments’ debt risk only focuses on maturity mismatch instead of insolvency or Ponzi financing.

In a word, within the current institutional arrangement, the risks of local governments’ debts are less than they seem to be. But it never means that governments should ignore the debt crisis.

As interest rate marketization has become an inevitable trend in China, it is very likely for the central bank to regulate monetary policies with price-based instruments instead of quantitative instruments. When it comes to realize, local governments have to face the soaring financing cost and the lost of preferential access for bank loans, so the safety margin of local governments’ debts will narrow down greatly and even disappear completely. At the same time, once the financial depress ends up, the land valuation will be suppressed for a long time, and this will greatly weaken the credit facility and debt paying ability of local governments from the source.

Where are the fundamental solutions? The way out for local governments’ debts is to get rid of the dependence for indirect financing channels like banks as soon as possible, and more rely on the direct financing.

Originally published on Oriental Morning Post | 2013-1-9