China’s Local Government Debt Is “Out Of Control”, Warns Auditor

By: EW News Desk Team   Date: 16 April 2013

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16 April 2013

Local governments from provinces, cities, counties and villages across China could owe somewhere between $1.6-$3.2 trillion to banks and other debtors, said a senior Chinese auditor on Tuesday, warning that the debt problem was “out of control” and could spark a bigger financial crisis than the US housing market crash.

Zhang Ke, vice-chairman of China’s accounting association, told the Financial Times that his accounting firm, ShineWing, had all but stopped signing off on bond sales by local governments; and said that most local authorities would struggle to repay their loans as “they don’t have strong debt servicing abilities.”

“Things could become very serious,” cautioned Zhang. “We audited some local government bond issues and found them very dangerous, so we pulled out.”

“It is already out of control. A crisis is possible... But since the debt is being rolled over and is long-term, the timing of its explosion is uncertain,” he added.

According to Zhang, the problem arose after Beijing loosened borrowing constraints in 2008 to soften the impact of the global financial crisis. Many local governments then invested in public projects that were generating lacklustre returns, and so were now relying on financing rollovers to pay back their creditors.

“This evolution was quite frightening,” he said. “China has more than 2,800 counties. If every county issued debt, it could lead to a crisis. It could be even bigger than the US housing crisis.”

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On Tuesday, Moody's Investors Services also lowered its outlook for the Chinese economy, claiming that the high borrowing by China’s local government and growing bank lending were sources of concern. The action was a repeat was one by Fitch Ratings last week, when it cut China’s long-term currency credit rating from AA-minus to A-plus.

Moody's said that Chinese authorities had not done enough to reduce the risks associated with local government contingent liabilities by improving transparency.

“Progress has been less than anticipated in the process of both reducing latent risks by making local government contingent liabilities more transparent and in reining in rapid credit growth,’’ the rating agency said in a statement cited by AFP. ‘‘Credit-positive structural reforms under the new leadership are expected over time, but their scope and pace may not be sufficient over the course of the next 12-18 months to justify a rating upgrade.’’

Former Finance Minister Xiang Huaicheng last week also urged the central government to get a handle on local governments’ debt.

“It seems the central government’s debt level is quite transparent, while local government debt isn’t, and therefore it’s not easy to get a clear picture,” Xiang said at the Boao Forum for Asia, as cited by Bloomberg.

While admitting that he had already retired and was no longer “within the system”, he further estimated that local government debts could be double than the reported figure, given in a 2011 report by the National Audit Office.

On its part, Beijing has already taken steps to control bond issuance by the local governments’ investment companies. In December, the finance ministry barred them from injecting public assets such as hospitals and schools into the special purpose vehicles they use to sell bonds.

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Zhang however cautioned against accepting any central government official guarantees, against local governments’ debt.

“When the time comes, it won’t be the government that assumes responsibility. It will be the accounting firms and the banks that do.”

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