China Faces ‘Mini Crisis’ on Debt Defaults, Ex-PBOC Adviser Says

China is headed for a “mini crisis” in its local-government debt market as economic reforms lead to the first defaults, according to a former adviser to the People’s Bank of China.

“It will be a partial, controllable and mini crisis,” Li Daokui told reporters on the sideline of the Credit Suisse Asian Investment Conference in Hong Kong today. “There’s tremendous room for the central government to fix the problems in local government debt. Defaults must be allowed to restructure the debt, which will definitely happen as part of the reform measures in the second half of this year.” Li is a former member of the PBOC’s monetary policy committee and is director of Center for China in the World Economy at Tsinghua University.

China’s town and cities took on debt to pay for subways, sewage works and roads to help finance a 4 trillion yuan ($646 billion) stimulus package unveiled by the government at the height of the global financial crisis in November 2008, two months after Lehman Brothers Holdings Inc. collapsed. Those borrowings are still climbing and refinancing is growing costlier as default risk builds amid slowing growth in the world’s second-largest economy.

The amount owed by local governments jumped 253 percent since 2008, Nomura Holdings Inc. estimated in a Feb. 25 report, and official figures indicate the total increased to 17.9 trillion yuan by June 30 from 10.7 trillion yuan at the end of 2010. The nation recorded its first onshore bond default this month and a private Purchasing Managers’ Index released yesterday suggested factory output is shrinking in March at the fastest pace since July.

No Lehman

Defaults by local governments won’t have knock-on effects on the overall economy, Li said in a Bloomberg Television interview today with Betty Liu. There is no chance of a “Lehman episode” as China has a high savings rate and the central government’s debt is low as proportion of gross domestic product, he said.

China will focus on allowing more access for private capital and carrying out expansionary reforms earlier than scheduled to combat the current slowdown, Li said at the conference. There will be no repeat of large-scale stimulus seen in the financial crisis, he added.

The yuan, which has lost 2.3 percent this year, will return to a strengthening trend from June or July, when the economy should show signs of recovery, Li said. The currency may deliver a mild appreciation this year and gain 3 percent to 5 percent over a 12-month horizon, he said. The yuan rose 0.05 percent to 6.1856 per dollar as of 3:48 p.m. in Shanghai.

“People are too pessimistic on China,” he said. “This should change by the middle of this year as the economy recovers.”

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