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China’s Local Government Debt:Issues and Concerns

Professor Ho-Mou Wu

National School of Development,

Peking University

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Issues and Concerns

• How bad is the local-government debt (LGD) problem in China?

• How does the LGD problem contribute to the risk faced by China’s economy?

• Can China resolve the LGD problem while facing a slowing economy in 2012 and beyond?

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Total Size of LGD

• Type I: the government bears the responsibilities of

repayment

• Type II: the government bears the responsibilities of

guarantee

• Type III: the government may have to take the

responsibility of rescue

Total: 10.717491 trillion yuan

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The Size of LGD

Total size: 10.717491 trillion RMB (26% GDP, 2010)

Data: National Audit Office of China, 2011

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Accumulation of LGD

Data: National Audit Office of China, 2011

70%

60%

50%

40%

30%

20%

10%

0%

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Data: National Audit Office of China, 2011

All Levels of Governments have LGD

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Data: National Audit Office of China, 2011

Regional Distribution of LGD

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Data: National Audit Office of China, 2011

Who owes the money?

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Local Government Funding Platforms

• Definition: Local Government Funding Platforms (LGFPs) are legal entities founded by local governments and its subsidiaries by means of financial appropriation or asset injection (such as land, equity, etc.), specializing in funding, investing, constructing, and operating public or quasi-public projects commissioned by local governments.

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Causes for Emergence of LGFPs

• Since the reform of tax-sharing system in 1994, financing capacity of local governments is significantly constrained.

• In the Budget Law of 1994, local governments are prohibited from issuing local government bonds, except as otherwise prescribed by laws or the State Council.

• As a result, LGFPs came into being to provide finance for local infrastructure construction, and to boost economic growth. At the end of 2010, there were 6,576 LGFs.

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Financing Modes of LGFPs

• 1. Bank loans: to apply for commercial bank loans collateralized with assets (usually the rights to the use of land) and generally guaranteed by local governments.

• 2. Cooperation between trust companies and banks: guaranteed by local governments, commercial banks and trust companies cooperate to issue trust financial products, and then loan to LGFPs by trust companies.

• 3. Financial products of banks: guaranteed by local governments, commercial banks issue financial products and loan to LGFPs.

• 4. Cooperation between local governments and trust companies: guaranteed by local governments, trust companies issue trust products and loan to LGFPs.

• 5. Issuance of quasi-municipal bonds: guaranteed by local governments, LGFPs issue corporate bonds to finance municipal infrastructure construction.

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Who Lend the Money?

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Year for debt repayment

Total of 3 types of debts

Type I Type II Type III

Debt volume Ratio Debt volume Ratio Debt volume Ratio Debt volume Ratio

2011 26246.49 24.49% 18683.81 27.84% 3646.24 15.60% 3916.44 23.46%

2012 18402.48 17.17% 12982.52 19.35% 2972.07 12.72% 2447.89 14.66%

2013 12194.94 11.37% 7991.36 11.91% 2265.98 9.70% 1937.60 11.61%

2014 9941.39 9.28% 6177.01 9.20% 2273.31 9.73% 1491.07 8.92%

2015 8012.26 7.48% 4934.69 7.35% 1780.66 7.62% 1296.91 7.77%

2016and beyond

32377.35 30.21% 16340.12 24.35% 10431.48 44.63% 5605.75 33.58%

Total 107174.91 100.00% 67109.51 100.00% 23369.74 100.00% 16695.66 100.00%

uint: 100 million yuan

Repayment Tension in the Coming Years

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Scale of Bank Loans to LGFPs

• Statistics of CBRC shows that as of Jun, 2010, the loan balance of LGFPs is RMB 7.66 trillion, in which 1.8 trillion (24%) can be covered by cash flow of the funded projects; 4 trillion (52%) has to rely on second repayment sources (mainly land-transferring fees); and 1.86 trillion (24%) has severe default risk.

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LGD Adds to China’s Debt Burden

China’s general government gross debt 2010: 13.46364 trillion yuan (Source: World Economic Outlook. Sep, 20th, 2011)

Chinese government’s total debt/GDP 2010:

=(13.46364+10.71749)/40.1202

=60.27%

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Risks Associated with LGD

• 1. Lack of monitoring channel for local government debt-raising and usage.

• The budgetary control system was not implemented in many local governments.

• Uncertain statistics in debt size and repayment responsibilities in some places.

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Risks Associated with LGD (Cont’d)

• 2. Inefficient Corporate Governance. Top management of many LGFPs is often appointed by local government, lacking sufficient management competency and risk consciousness.

• 3. Over-reliance on Land Transferring Fees.

- Bank loans to LGFPs are generally guaranteed by local governments.

- The guarantee is based on expectation of rising land transferring prices.

- If land price drops, it is difficult to repay bank loans, and the local government has to appropriate other financial funds.

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Recent Rules and Regulations on LGFPs

• On Jun, 10th, 2010, the State Council promulgated “Circular on relevant issues Concerning Strengthening the Administration on LGFPs” , to comprehensively plot management of LGFPs.

• On Jul, 30th, 2010, MOF, NDRC, PBC, and CBRC promulgated “On Implementing Circular from State Council on Strengthening Management of LGFPs”, which required local finance authorities report debt clearance and verification of LGFPs before Oct, 31st, 2010. It also requires new LGFPs established after Jul,1st, 2010 pay up capital and prohibits the injection of welfare fund-related assets as capital.

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• On Nov, 10th, 2010, CBRC promulgated “Notice on Verification of Loans Ledger to LGFPs” to commercial banks, planning to conduct dynamic management of LGFPs.

• On Nov, 20th, 2010, NDRC promulgated “Circular on Relevant Issues on Further Disciplining Bond Issuance of LGFPs”, which stipulated that repayment funds of LGFPs that issue corporate bonds should be no less than 70% of its retained earnings, and LGFPs are prohibited to issue bonds if the debt level of the reference local government exceeds100%.

Recent Rules and Regulations on LGFPs (Cont’d)

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Recent Rules and Regulations on LGFPs (Cont’d)

• In Dec, 2010, CBRC promulgated “Guiding Opinions of Strengthening Management of Credit Risk of LGFPs”, specifying risk weights, provision coverage requirement as well as classifications of loans to LGFPs.

• Starting in July, 2011, new financing by LGFPs has been prohibited.

• On Oct, 20th, 2011, the State Council allowed Shanghai, Shenzhen, Zhejiang, and Guangdong to issue local government bonds. Shanghai raised 7,100 million yuan successfully on Nov, 16 th, 2011.

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Prospects

• China needs to strengthen fiscal discipline on government expenditures at all levels.

• China needs to reconsider the sharing of tax revenues among the central government and local governments.

• May allow more local governments to issue bonds so as to impose market discipline and budgetary control on local governments.

• About 1.8-2.5 trillion yuan LGD may become bad loans for China’s banking system.

• The central government may step in as the LGD problem worsens.