Cover Editorial - EO print edition no. 429
Translated by Yao Bo
Original article: [Chinese]

One month ago, a group of officials from various branches of the State Council conducted an inspection tour of regional China. They were examining the financing programs that had been set up throughout the provinces in order to deliver the investment commitments contained in the government's 4 trillion yuan stimulus package.

Although it's impossible for us to know the contents of the official report that will soon be submitted to policy makers, it's more than likely that regulatory bodies have been paying close attention to the potential risks involved in local government financing.

The economic stimulus package has been driving the huge growth in local government spending. In order to maintain growth, local governments have been required to match the 1.18 trillion yuan that the central government has committed over the coming two years.

However, although local governments in China do not have the authority to raise funds through selling bonds, they're still required to come up with money when it comes to providing public facilities or looking after the welfare of their constituents.

Since the end of last year, a swathe of local projects have been approved and local governments have mainly turned to city investment companies to help them to raise capital.

However the risks involved are huge. Many of the loans taken out by the local governments in this way, carry an implicit guarantee because the loan is in essence backed by the state. The loans are to be paid back with profits raised from local government land sales.

The problem is, the land is likely to have already been pledged multiple times and the earnings on the land sales are subject to fluctuations in the market. If the economy experiences a downturn, the earnings that the lenders could expect would start to fall.

Furthermore, nobody can be sure exactly how much local governments have borrowed from the banks. Finally, as local governments cannot  be bankrupted, it could end up being a nightmare for the banks and the financial system as a whole.

We see no signs of a decline in local financing, on the contrary, they appear to be making every effort to raise even more money. It seems likely that policy makers will unveil some regulations and other limits to stem the risk involved.

However, we don't think this is the best way to go about solving the problem. At the beginning of this year, various national ministries opened the "back window" to allow local governments to raise money in a unorthodox way, but why didn't they just open the "front door" and allow local government's to legitimately raise funds by issuing bonds?
This spike in local government lending is bound to increase local debt. And nobody, not even local government themselves, has any idea of how much money has been borrowed.

Furthermore, these debts are not likely to appear on the books of any local government's budget, even though attempt to hide them are simply a form of self-deception. But once the debt finally catches up with them, there will be nothing that they can do to avoid the disastrous consequences.

If this is the case, why not simply give local governments the responsibility to raise money through selling bonds?

Though the central government has approved local debts this year, it's been carried out under the name of the central government, a process through which many disadvantages are soon likely to emerge. One major problem with the method is, since local governments are not real lenders, nobody is able to calculate their credit rating and it's not possible to set a market price for a local government bond.

Some observes argue that if local governments were allowed to issue their own bonds, it would spur a large-scale issuance spree that would only further increase the risk of default. But we think the key point is the system. At the same time that local bonds are allowed to be issued, a stock take of all existing debts should also be carried out, and a system that allows local governments to go bankrupt could also be established.

We should notice that many local governments do not allow private enterprises to invest in public utilities such as highway and railway construction companies, and they're able to monopolize investment in those sectors. But, if we expand the means by which local governments can raise money, and at the same time open the door to private capital, it won't be necessary to worry about the "future of money."