As the U.S. government grapples with its fiscal issues at the national level, Chinese authorities are wrestling with local government debt problems, according to a report released Monday by Standard Chartered.
The report, written by Stephen Green, looks at the scope of the problem–now about $1.5 trillion to $2 trillion (or 10 trillion to 14 trillion renminbi)–and possible solutions.
In “China–Solving the Local Government Debt Problem,” Green said, “Relying on tax revenues and land sales will probably not work, we argue: The funds available are simply not large enough. Neither are the banks in a position to digest more than a small part of the potential loan losses. We believe that the problem will need some kind of central-government resolution.”
While a significant hurdle, the local debt problem need not necessarily trigger a banking crisis or a macro-economic slowdown, Green argues. “The central government’s balance sheet and tax collection capabilities combined with strong nominal growth should mean this challenge can be met,” he said.
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In the short run, the Standard Chartered analyst believes the Ministry of Finance (MoF) needs to boost infrastructure spending to provide required liquidity for troubled projects and stabilize the most exposed banks.
At least one of the national policy banks should get involved, Green adds, by issuing bonds, buying nonrevenue-generating loans from the banks and managing projects through to completion. Also, some budgetary revenues and a portion of land-sale revenues should be used to finance an Infrastructure Sinking Fund (ISF), which would be used to buy back bonds over 2012-2015.
Other needed reforms include: more centralized responsibility for spending, published government budgets and increased local-government autonomy in revenue-raising and debt issuance.
According to provisional figures from the China Banking Regulatory Commission (CBRC), about 2 trillion to 3 trillion renminbi ($300 billion to $450 billion) or 6% of GDP) of local government investment vehicle (or LGIV) loans are in trouble.
“We believe that repayment problems will likely spread across the country, and that a formal central-government led LGIV debt-resolution mechanism will soon be required. There are signs that Beijing is already considering some kind of bailout mechanism,” Green said.