China Downplays Local Government Debt Risks, Looks at Bond-Sale Mechanism

China’s finance ministry said local governments’ debts are controllable, seeking to damp concern that the nation’s record lending boom will lead to a jump in bad loans.

China will speed up studying a mechanism for local governments to sell bonds, an unidentified official from the Ministry of Finance said in a report posted on its website today. They should no longer set up companies to fund public projects off their balance sheet or guarantee their debt, the official said.

Standard & Poor’s estimates that as much as 30 percent of China’s lending to local governments may go sour, after the outstanding loans reached 10.7 trillion yuan ($1.7 trillion) at the end of 2010. The banking regulator told lenders they haven’t set aside sufficient funds to cover losses on local government loans and ordered them to accelerate collections, a person familiar with the matter said last month.

“They will need to sell some assets, it is unavoidable given their cash flow condition,” said Wei Yao, a Hong Kong- based economist with Societe Generale SA. “But I don’t expect them to conduct large-scale sales of assets because that’s basically privatization.”

Local governments can liquidate their assets to help them pay back their debt, the Finance Ministry official said in the statement today, rather than using them as collateral to borrow by the local financing vehicles.

The government is trying to build confidence that it can solve the problem given the debt problems in the U.S. and European markets, Yao said. “At the end of the day the local governments still need cash from either the central government or somewhere else.”

Bad Debt

China’s banking sector non-performing loan ratio is already at 7 percent and local government debts could push that above 16 percent, Yao said.

Moody’s Investors Service estimates regional authorities’ bank loans total about 3.5 trillion yuan more than the official 10.7 trillion yuan and that bad debt may account for as much as 12 percent of total credit, according to a report published last month.

“When you look at their ability to repay debt, apart from fiscal income, China’s local governments have fixed assets, land, natural resources and lots of other assets,” the Ministry of Finance report said. “China’s economy is also at a stage of fast growth.”

In some areas where debt levels exceed fiscal income, risks can be controlled by limiting the amount of new debt, it said. Infrastructure construction will also help local economies and government income, improving their ability to pay back debt, according to the report.

Still, some regions’ and industries’ ability to meet liabilities is weak, the report said. Some local governments rely too heavily on land income to pay back debt, and some expressways and other roads have heavy debt loads, it said.

Hidden Risks

“In areas or industries where there are hidden risks, we should plan ahead, adopt effective measures, appropriately deal with existing debt, and strictly control the buildup of new debt, to prevent and reduce possible risks,” it said.

The article didn’t say what measures would be taken. It said municipal bonds would allow local governments to get funds in times of crisis and natural disasters.

Separately, China’s local governments will see 4.6 trillion yuan of debt, or 43 percent of their total borrowing, mature by next year, the China Securities Journal reported, citing an unidentified person. The banks will also reclassify around 2.8 trillion yuan of the loans as “general” corporate lending, it said.

Risk Weighting

The risk weighting for banks on local government loans is 300 percent, the China Securities Journal said, three times as high as ordinary company loans. Some 4.46 trillion yuan of local government debt is due this year and next year, the national audit office said June 27.

China’s finance ministry has drafted a preliminary plan that would allow some provincial and city governments to sell bonds to investors on a trial basis, a person with knowledge of the matter said Aug. 4.

The proposal aims to boost local authorities’ repayment ability, the person said, declining to be identified as the matter is confidential. Local government liabilities fell to 7.1 trillion yuan as of June 30 after banks reclassified 2.1 trillion yuan as normal corporate credit with sufficient cash flows to meet obligations, the person said.

--Henry Sanderson. Editors: Stephanie Wong, Ed Johnson

To contact Bloomberg News staff for this story: Henry Sanderson in Beijing at +86-10-6649-7548 or hsanderson@bloomberg.net

To contact the editor responsible for this story: Shelley Smith at ssmith118@bloomberg.net

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