Detroit Bankruptcy:A Warning for China?

by Zi Mo

On July 18， 2013， the city of Detroit， once the hub of the U.S. automobile industry， filed for the largest municipal bankruptcy in the countrys history. The news also stirred worries about the fast-expanding debt of Chinas local governments.

Debt Snowball

A report released by the National Audit Office （NAO） of China in June shows the combined debt of 36 local governments audited at 3.85 trillion yuan at the end of 2012， up 12.94 percent from 2010. Of them， 16 regions had a liability ratio surpassing 100 percent， with the highest reaching close to 220 percent in consideration of its warranty liability.

Experts believe the reported amount is only the tip of the iceberg. Huatai Securities estimates that Chinese local governmental debt， including borrowing by local government financing platforms， local government bonds， and municipal investment bonds， totaled 15.3 trillion yuan by the end of 2012. According to Dong Dasheng， deputy auditor-general of NAO， the total amount of local government debt might sit between 15 and 18 trillion yuan. At the Boao Forum for Asia held last April， former Chinese Minister of Finance Xiang Huaicheng estimated that the figure might exceed 20 trillion yuan.

How did local governments amass such massive debts？ To a large extent， the phenomenon stems from the unlimited liability of Chinas local governments， whose budgets need not only cover operational and public expenditures， but also direct and indirect investments aiming to bolster the local economy. As a matter of fact， the latter contributes to the majority of local government debt.

Statistics show that 36.5 percent of local government debt was used for urban infrastructure construction and 25 percent for transportation projects. Previously， under an evaluation mechanism focusing on GDP growth， local governments were always willing to borrow to invest in infrastructure projects， resulting in the snowballing of local government debt.

Along with Chinas economic transformation， such an investment-driven growth mode has been deemed unsustainable.“The recent moves of the State Council of China reveal that top authorities have realized the importance of economic restructuring and technological innovation，” notes Yao Shujie， head of the School of Contemporary Chinese Studies at the University of Nottingham. “In other words， the previous extensive growth pattern deeply relying on real estate sales has become unworkable.”

Debt Crisis or Financial Problem？

Currently， the total of local government debt in China continues mounting. However， due to the slowdown in the countrys economic growth， prospects for revenue increases dont appear promising， further increasing the risk of debt default. Some even worry that local government debt has become a ticking time bomb that will likely trigger Chinas “subprime mortgage crisis.” Xia Bin， a counselor with the State Council， ranked the risk arising from local financing platforms as one of the three major hazards threatening Chinas economy， together with real estate bubbles and financial system risk.

However， Song Li， deputy director of the Institute of Economics of the National Development and Reform Commission（NDRC）， doesnt agree that local government debt has become a crisis. “Most local government debts are short-term，” he explains. “The major problem is about liquidity， which is essentially a financial problem rather than an economic problem. Detroit is on a downturn course， but Chinese cities are maintaining an upturn in development. Its natural for local governments to borrow to invest in transportation and public housing projects. But， the majority of the debt is accrued by acquiring high-quality assets， so it wont result in a debt crisis. The pressure mainly comes from debt maturity mismatches.”

Even so， Lin Yongming， head of the Research Group on the Sustainability of Local Government Debt Financing under the NDRC Investment Research Institute， still warns that the risks of local government debt should not be neglected. “So far， the expansion of local government debt has been under control， and acute symptoms that may affect the nations macro-economy have been addressed. But， we still need time to treat the chronic symptoms.”

This Is Not an Exit

Some local governments have exploited new investment patterns in infrastructure projects. It is reported that Jiangxi Province recently established a 15 billionyuan railway industry investment fund， with a first phase investment of 5 billion yuan， which allows state-owned enterprises to invest in railway projects， so as to ease the financing pressure on local governments. Last year， Beijing Financial Street Capital Management Center was founded， which incorporates shares of some stateowned enterprises of Xicheng District， with the investment and financing capacity to support major projects in the district.

As the central government strengthens its regulation of incremental debt of local governments， the situation is improving. Data has shown that regulatory authorities have noticed the potential risks of the huge amounts of local governmental debt， and attempted to eliminate the risks before they become unmanageable. According to Chinese Minister of Finance Lou Jiwei， the country will gradually categorize and incorporate local government debt into fiscal budgets and build a standardized financing mechanism for local governments， so as to prevent financial risk. To realize that goal， however， a long road ahead awaits.