Is the Next Detroit in China?

Wenzhou is among the cities most heavily indebted and at risk of defaulting on its loans, according to Nomura Holdings Inc

Wenzhou To Start Trial of Small-Business Funding Program
Qilai Shen/Bloomberg

Wenzhou is among the Chinese cities most heavily indebted and at risk of defaulting on its loans, according to Nomura Holdings Inc.

In a new analysis described as one of the first of its kind, Nomura has dug into China's lending trail to see which cities and provinces are creaking under debt. They examined credit risks covering 30 provincial authorities and 265 cities.

The report comes as bad loans and defaults in China tick higher and local governments struggle to meet repayments after years of binge borrowing to build roads and bridges and keep the economy growing. Mizuho Securities Asia estimates China's regional liabilities have now reached 25 trillion yuan ($4 trillion), bigger than Germany’s economy.

Here's what Nomura's research found: the highest default risk is concentrated in the coastal and western provinces. Central China fares better. The danger provinces include Qinghai, Zhejiang, Liaoning, Hainan, Jiangsu, Fujian, Guizhou, Gansu, Chongqing and Heilongjiang.

"Assessing the geographic distribution of risks is becoming increasingly important, particularly as China’s bond market is on the verge of explosive growth," Nomura analysts led by Yang Zhao wrote in the report.

Source: Nomura Holdings

Among the cities, about 60 so-called third and fourth-tier cities carry the highest risk. These include: Datong in Shanxi province, followed by Sanya in Hainan, Wulanchabu in Inner Mongolia, Ganzhou and Shangrao in Jiangxi, Lishui in Zhejiang, Wenzhou in Zhejiang and Bazhong in Sichuan. First-tier cities like Beijing and Shanghai fared better in the analysis, helped by stronger economic fundamentals. 

Nomura used 13 indicators that cover four risk areas: property market, fiscal, financial and economic fundamentals.

China isn't the only country with heavily indebted cities or state governments. In the U.S., Detroit and Stockton, California both emerged from bankruptcy in the past year.

It's the pace of Chinese borrowing and a lack of transparency around how much debt there is that has investors worried. Nomura estimates that China's local government bond market may balloon from around 1.2 trillion yuan to 12 trillion yuan by 2020.

A string of defaults would gum up the lending system, bring economic growth to a halt and runs the risk of social unrest. So the idea is to keep the credit flowing.

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