Photo Credit: AFP/Getty Images/Frederic J. Brown
Four trillion yuan ($682 billion) of bank loans made to China’s three top tiers of local government – provinces, municipalities and counties – fell due for repayment at the end of last year. Three quarters of it couldn’t be repaid, the Financial Times estimated last week. That is approaching half a trillion dollars worth of debt. China’s state-owned banks performed their patriotic duty and rolled over the loans to avert wide-scale defaults.
We were reminded of John Paul Getty’s famous remark: owe the bank $100 and you have a problem; owe the bank $100 million and it is the bank that has the problem. Owe the bank $482 billion and the banking system might have a problem. That has been the fear of some policymakers in Beijing.
The borrowing had been taken on in large part to pay for the infrastructure spending that comprised Beijing’s massive stimulus program in the wake of the 2008 global financial crisis. Borrowing short-term to finance long-term obligations such as highway construction isn’t prudent at the best of times. Nor was last year the best of times. China’s GDP growth slowed mid-year to barely 7%, still brisk by world standards — though it didn’t feel like it in a country used to decades of double-digit growth.
Up to a point, the banks had little choice but to bail out local governments. It is not practical to foreclose on a half-built bridge or highway. But it is equally clear that they needed to forestall a disaster that China’s policymakers have feared for some years, an explosion of the local government debt bomb.
Beijing may have ordered up the stimulus package in 2008 but local governments largely footed the bill. Local government debt rose by 62% in 2009 over the previous year. Their bank borrowing increased by a further 19% in 2010. By the end of that year, China’s central government debt was a modest-looking 17% of GDP. Its local government debt was the equivalent of 27% of GDP. Alarm bells were already ringing at the China Banking Regulatory Commission about the build-up of potentially bad loans on the banks’ books when in March 2011, the finance ministry alerted the National People’s Congress (NPC) that “local governments face debt risks that cannot be overlooked.”
What particularly concerned officials were the risks involved in the 7.7 trillion yuan of bank loans (as of June 30, 2024) made to local governments’ captive investment companies, off-balance sheet vehicles to skirt restrictions on direct borrowing. A finance ministry audit had turned up more than 6,000 of them, without even looking in all the provinces. The audit also found that there was no cash flow to repay 23% of their loans. It is a fair bet that by the time the ministry made its report to the NPC the numbers had worsened significantly. By November 2011, China’s local government debt had reached 13.7 trillion yen ($2.2 trillion; Italy’s outstanding sovereign debt at the time was $2.6 trillion) including a previously uncounted 3 trillion yuan borrowed by townships, the administrative tier below counties.
Reforms to local government finance started to be put in place. The finance ministry quintupled the quota for local government bond issuance to 250 billion yuan. A rolling 2 trillion-3 trillion yuan bailout shored up loans backing projects with neither collateral nor viable cash-flow to cover debt service. Banks were also made to plump up their cushions of capital reserves. These measures kept the situation manageable through last year and to get local governments – and the banks – through year’s end in tact. The risk of a local government debt default will remain low – as long as economic growth remains brisk and state-owned banks can be relied upon to absorb the worst bad debts.
What is not low is the challenge China’s local governments face in working down their debt load. Banks have all but stopped extending new loans to local governments. Some authorities are tapping the nascent municipal bond market to raise new debt, but they are the larger, most credit-worthy ones, mostly provinces or province-level municipalities, and the sums involved are small in comparison to the overall debt.
Others have turned to the shadow banking system, the network of unregulated financial institutions, including trust companies that are being used by local authorities like the old special investment vehicles. There have been defaults and near-defaults around these in the past couple of months. None catastrophic. At least not yet.
