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China May Assume Some Local Government Debt, Reuters Says

China plans to shift as much as 3 trillion yuan ($463 billion) of debt off of local governments, reducing the possibility of defaults that could threaten stability, Reuters reported, citing unidentified people.

The central government will pay off some local debt and make state-owned banks write off some bad loans, the news agency reported yesterday. China will also end a ban on provincial and municipal governments selling bonds, according to the report.

Chinese cities and provinces, also currently barred from directly taking bank loans, have set up about 8,800 companies to fund infrastructure projects, Credit Suisse Group AG estimates. Fitch Ratings cited the risk from these vehicles, used to fund stimulus spending from the 2008 global financial crisis, in lowering its outlook on China’s AA- long-term local-currency debt rating in April.

“Many of those loans will not be repaid and ultimately it is the central government that will probably have to bail out either the banks or local governments, or both more likely, as they did a decade ago,” Qinwei Wang, China economist at Capital Economics Ltd. in London, said in an e-mail response yesterday to questions from Bloomberg News.

Debt Clean Up

The National Development and Reform Commission, the Ministry of Finance, and the China Banking Regulatory Commission plan to start cleaning up the debt in June and end in September, Reuters reported, citing one of two people interviewed by the newswire. The other person said the program may take longer, Reuters reported.

Xu Lin, head of the department of fiscal and financial affairs at the NDRC, said he hadn’t heard of the local government debt plan reported by Reuters. The commission, China’s top economic planning agency, approves bond sales by local government financing vehicles.

Allowing local governments to directly sell bonds would also require the nation’s budget law to be revised, Xu said. Revisions haven’t been made, he said.

Jia Kang, head of the Ministry of Finance’s research department, said he’d also not heard of the plan. A press official at the banking regulator, who declined to be identified because of the agency’s rules, couldn’t immediately comment.

Local government financing vehicles had loans totaling 9.09 trillion yuan at the end of November, with 1.77 trillion deemed to have repayment risks, the 21st Century Business Herald newspaper said in March.

Banking System

The fiscal position of the central government has strengthened compared with 10 years ago, Capital Economics’s Wang said. Large losses at banks from local government debt would mean that China will have an inefficient banking industry for at least a few years, possibly damping growth, he said. Assuming local government debt of 10 trillion yuan, the debt-to- GDP ratio is about 70 percent, Wang said.

Growth is already slowing in the world’s second-biggest economy as policy makers raise interest rates and order banks to hold more assets in reserve as they seek to temper inflation. A survey of purchasing managers published today showed manufacturing expanded in May at the slowest pace in nine months.

To limit risks for banks, China increased oversight of lending to the local-government vehicles, which surged during the nation’s two-year stimulus program. In March, Premier Wen Jiabao pledged a “comprehensive audit” of local debt.

Bank Profits

Regulators are unlikely to order Chinese banks to write off local government loans, said Wilson Li, a Shenzhen-based analyst at Guotai Junan International Holdings Ltd. Such loans account for about 19 percent of outstanding credit and write downs would have an “obvious impact” on banks’ profits, he said.

Hu Changmiao, a Beijing-based public relations official for China Construction Bank Corp. (939), said he was unaware of “any new instructions from the regulators on cleaning up local government financing vehicle loans.”

China’s last banking crisis was in the late 1990s, when years of state-directed credit left lenders saddled with bad loans, forcing the government to spend more than $650 billion over a decade in bailouts.

In 1999, Chinese authorities decided to liquidate Guangdong International Trust & Investment Corp. after the company racked up more than $4 billion of foreign debt. Gitic, as it was known, was a financing company owned by the government of southern China’s Guangdong province and was the first case in which China refused to bail out foreign creditors.

The big-four government-owned banks -- Industrial & Commercial Bank of China (1398) Ltd., Bank of China Ltd. (3988), China Construction Bank and Agricultural Bank of China Ltd. (1288) -- all boosted their capital last year in the aftermath of the record credit expansion unleashed as the global recession hit in 2008.

Along with Bank of Communications Co., five Chinese lenders control about half of the nation’s banking assets. The group raised $56 billion selling shares and convertible bonds last year.

--Josh Fellman, Henry Sanderson. With assistance from Winnie Zhu in Shanghai, Stephanie Tong in Hong Kong, Zheng Lifei and Victoria Ruan in Beijing. Editors: John Liu, Paul Panckhurst

To contact the Bloomberg staff on this story: Henry Sanderson in Beijing at hsanderson@bloomberg.net Joshua Fellman in New York at jfellman@bloomberg.net

To contact the editor responsible for this story: Paul Panckhurst at ppanckhurst@bloomberg.net

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