China doesn’t face a debt-default risk

The ratio of outstanding government debt by the end of a year to that year’s GDP is a key indicator of whether a government faces a debt-default risk. The debt ratio can reflect an economy’s ability to repay its debts. Studies show China’s overall debt is under control, as its debt ratio is within safety limits and sovereign balance sheet is quite sound — the total debt ratio of China’s central and local governments was 38.8 percent at the end of 2016, far lower than the 60 percent red line set by the Maastricht Treaty signed by European Community members in 1992 to integrate Europe.

China’s liability ratio, too, is lower than the ratios of major economies and some emerging market economies, and even lower than the members of the Organization for Economic Cooperation and Development.

China’s debt ratio is 52.97 percentage points lower than the average of the OECD members — the central government’s debt ratio is 62.68 percentage points lower than the OECD members’, though the local governments’ ratio is 9.71 percentage points higher than the OECD average.

Besides, whether a government faces a debt risk should be judged not only in terms of debt expansion, but also by the size of the economy, that is, whether it has enough resources at its disposal to pay down the debt in the face of a financial risk.

In-depth research into China’s sovereign balance sheet in recent years shows the continued increase in leverage has led to rising debt since the global financial crisis in 2008, but correspondingly the country’s sovereign assets have also expanded, yielding a high level of net value for the Chinese government. For example, in 2015, China’s net asset value was 101.8 trillion yuan ($16.21 trillion), the country had sovereign assets totaling 241.4 trillion yuan, and a debt of 139.6 trillion yuan. So, given the low liquidity of State assets of administrative organs and limited transfer of land rights, China’s sovereign net assets will remain positive even after deducting 16.2 trillion yuan from State assets and replacing 68.5 trillion yuan land assets with 3.1 trillion yuan worth of land-transferring fees.

State assets, including operating assets and some natural resources, are important guarantees for debt repayment. Although China has sufficient sovereign assets to cover the liabilities, it may sometimes face difficulties in repaying some debts. It should be noted, however, that the State assets may be underestimated and the debt overestimated.

Since the State assets’ value was measured using historicalcost accounting, the net value of the assets and the government’s ability to repay could increase if it is measured in terms of market value or fair value. And debt could be overestimated, because by simply adding up certain liabilities and contingent liabilities, and using different probability methods for transferring contingent liabilities will lead to different outcomes. Also, except for losses in contingent liabilities, other non-performing debts such as subordinate loans and doubtful loans, in fact, can be partly repaid. Therefore, the real amount of sovereign net assets is likely to be much higher.

China’s high net asset value structure is very different from those of major developed countries, because its resident sector, private enterprises and government departments (including State-owned enterprises) account for about one-third each of the total net assets while in developed economies, the resident sector accounts for 70-80 percent of net assets, with the public sector having a small share. Hence, with sufficient stock assets and other available resources, China’s debt would be less risky.

However, China’s debt problem, especially the local governments’ debt problem, deserves special attention, and the authorities should not ignore the root cause of what could be a systemic problem. To prevent any poten- tial debt risk, the first thing to do is to deepen institutional reform to curb debt growth. There are four specific suggestions for achieving the desired results:

First, the authorities should further promote market-oriented bond issuance to check the rise of local governments’ debt. Actually, the local governments’ bond market has greatly improved in terms of marketization in recent years, although there is still room for improvement, especially in the bond issuance pricing mechanism. The low bond spread indicates the existing pricing mechanism doesn’t reflect the true market value of some local government bonds and their cost of risk.

The authorities therefore should establish a market-oriented pricing mechanism with less administrative intervention — this is also important to increase the marketization of local debts and realize differential pricing regionally.

Second, a sound credit rating system should be established for the issuance of local bonds, while promoting information disclosure and market supervision on local loans can increase the local governments’ financial transparency and make them more selfdisciplined.

Third, a capital budget system should be established immediately to tighten regulations especially on State financing. And to minimize the debt risk from the very beginning and make fund allocation more efficient, it is necessary to work out a mid-term financing plan for major infrastructure construction projects, extending it later to cover all infrastructure projects. This plan should cover all sources of funding from all levels of government, such as financial subsidies, equities and debt financing.

And fourth, a regulation is required to impose severe penalties on the local governments that fail to reduce debt. There is also a need to set up a financial bankruptcy system for the local governments to curb debt.

Local authorities are responsible for repaying their respective local governments’ debts, and the central government is not obligated to bail them out, says the contingency plan to deal with the local governments’ debt released on Nov 14, 2016. The plan also says the ability to control the debt risk should be incorporated in the performance and promotion of local government officials. Holding the local municipal and county administrations responsible for debt restructuring, based on the cause and time period of their debt risks, will be a serious warning to those local governments that have run up huge debts.

After the provincial governments start shouldering more responsibilities for municipal and county administrations in terms of financial management, the central government should distance itself from the local governments on debt repayment so that the latter can independently establish their credit rating system and curb opportunism.

The central government should also further diversify bond investors — for example, stock exchanges and commercial banks can issue some enterpriseand individual-oriented bonds, or explore better ways to issue bonds for institutional investors with social insurance funds, housing provident fund or supplementary pension. The reform can also help solve the problem of almost all investors flocking to commercial banks, by promoting financial liquidity in the secondary market and attracting locals to supervise government finances.