MAN­AGE­MENT Clar­ity key to lo­cal govt debt

China Daily (Hong Kong) - - BUSINESS VIEWS - ZHENG YANGPENG

There is a pop­u­lar say­ing among ad­ver­tis­ers that “we know half of what we spent was wasted un­for­tu­nately, we just don’t know which half”.

The same now can be ap­plied to China’s lo­cal govern­ment debts.

“We know maybe half of their debts have re­pay­ment prob­lems, we just don’t know which half.”

This is why China’s National Au­dit Of­fice’s lat­est cam­paign to in­ves­ti­gate all govern­ment debts is a wel­come move.

Since the end of 2010, when the National Au­dit Of­fice con­ducted a na­tion­wide au­dit and con­cluded that lo­cal govern­ment debts stood at 10.7 tril­lion yuan ($1.75 tril­lion), there has been no of­fi­cial na­tion­wide sur­vey.

Al­though the con­sen­sus is China’s lo­cal govern­ment debt ex­pe­ri­enced an­other round of rapid ex­pan­sion in 2012, when the cen­tral govern­ment al­lowed an­other stim­u­lus pro­gram in face of eco­nomic slow­down, how much the debt ex­actly is, and how much will ma­ture over the next year has be­came a wild guess­ing game among ex­perts, for­eign in­vest­ment banks, credit rat­ing agen­cies, in­vestors and even the govern­ment it­self.

Vice-Fi­nance Min­is­ter Zhu Guangyao ad­mit­ted ear­lier this month that the govern­ment did not know pre­cisely how much debt lo­cal gov­ern­ments had built up.

The lack of clar­ity is down to the ab­sence of thor­ough in­ves­ti­ga­tion since 2010. Al­though the au­dit of­fice in June put to­tal debt of a sam­ple of 36 lo­cal gov­ern­ments at 3.85 tril­lion yuan ($628 bil­lion) at the end of 2012, the whole pic­ture can­not be seen.

The lack of clar­ity is also be­cause of the na­ture of the lo­cal govern­ment debts. Be­cause most Chi­nese lo­cal gov­ern­ments are not al­lowed to is­sue bonds di­rectly ac­cord­ing to the bud­get law, they have bor­rowed heav­ily through the so-called “lo­cal gov­ern­ments fi­nanc­ing ve­hi­cles”. At first glance, th­ese LGFVs, ti­tled “in­vest­ment and de­vel­op­ment cor­po­ra­tion of X city” or “as­set op­er­a­tion and man­age­ment cor­po­ra­tions of X city”, look like in­de­pen­dent com­pa­nies and the bonds they is­sue are counted as cor­po­rate debts. But their op­er­a­tion is un­der the di­rect dis­posal of lo­cal gov­ern­ments and their debts are im­plic­itly guar­an­teed by lo­cal gov­ern­ments. Be­cause no law re­quired dis­clo­sure of th­ese com­pa­nies’ li­a­bil­i­ties, the size of the debt is largely vague. They have been de­scribed by the Chi­nese me­dia as “black holes”.

Chi­nese banks do not know the size of th­ese debts ex­actly ei­ther, al­though they are the ul­ti­mate lender to th­ese cor­po­ra­tions. This is be­cause they ac­tu­ally do not have to con­duct pro­fes­sional credit rat­ings for th­ese bonds. The im­plicit govern­ment en­dorse­ment be­hind LGFVs made them adorable ap­ples of the eyes of banks. Banks know that even if LGFVs de­fault, the govern­ment will re­pay, ei­ther by pub­lic fi­nance stock or sale of land.

Banks also do not know the ex­act bor­row­ing cost of LGFVs be­cause they do not di­rectly of­fer loans to them, in­stead us­ing trusts firms or other agents. Chan­neled through th­ese agents, lo­cal govern­ment bor­row­ing rates were raised. But lo­cal gov­ern­ments still pre­fer th­ese chan­nels be­cause the rate is lower than that of a bank loan.

The LGFV bonds were so pop­u­lar that trust firms chased be­hind lo­cal gov­ern­ments to buy them. Tang Jian­wei, an econ­o­mist with Bank of Com­mu­ni­ca­tions, said the amount of to­tal so­cial fi­nanc­ing was boosted in the first half of this year pri­mar­ily be­cause of LGFVs and prop­erty com­pa­nies. The two in­dus­tries, largely barred by reg­u­la­tors from tak­ing out bank loans, man­aged to bor­row from the shadow bank­ing sys­tem and are es­ti­mated to con­trib­ute to about 70 per­cent of the to­tal so­cial fi­nanc­ing in the first half.

This has made them “the sword of Damo­cles” hang­ing over China’s bank­ing in­dus­try. Ac­cord­ing to Liu Dong­min, a re­searcher with the In­sti­tute of World Eco­nomic and Pol­i­tics un­der the Chi­nese Acad­emy of So­cial Sciences, bonds is­sued by LGFVs ac­counted for 84 per­cent of China’s cor­po­rate bonds in 2011.

But Liu also said the pos­si­bil­ity of mas­sive de­fault is very low, be­cause many of the projects in which lo­cal gov­ern­ments in­vested have de­cent re­turns. Even if rev­enue from the pro­ject it­self could not re­pay the debts, lo­cal gov­ern­ments could use their fis­cal rev­enue to re­pay them.

The prob­lem is, how can we get to know ex­actly how large a pro­por­tion of China’s projects have a de­cent re­turn and are fi­nan­cially sus­tain­able? Guan Qingyou, as­sis­tant dean of the Min­sheng Se­cu­ri­ties Re­search In­sti­tute, said so long as the projects have good cash flows, re­pay­ment is not an is­sue. But the prob­lem is we have no clar­ity re­gard­ing th­ese projects. This has made China vul­ner­a­ble to for­eign in­sti­tu­tions’ ac­cu­sa­tions that the lo­cal govern­ment debt prob­lem is a “time bomb” in China’s fi­nan­cial sys­tem, be­cause there is no solid data to deny it.

This is why trans­parency is so im­por­tant to the is­sue. Govern­ment in­er­tia is in dan­ger of caus­ing for­eign in­sti­tu­tions’ col­lec­tively to be pes­simistic. In­vestors, home and abroad, are ea­ger for the find­ings of the National Au­dit Of­fice, even the re­sult may be worse than peo­ple have imag­ined.

Talk­ing about debt is hardly a sexy topic. Think about in­for­ma­tion tech­nol­ogy, 3D print­ing, cloud com­put­ing just about any­thing is more ex­cit­ing than debt. But if new tech­nolo­gies rep­re­sent the fu­ture, debt is the past. We can never ar­rive in the fu­ture un­less we fig­ure out what the past is. Con­tact the writer at zhengyang­peng@chi­nadaily. com.cn

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