Mitigating Debt Bomb for Chinese Local Governments

By Xi Si, Zhang Xiangdong, Cheng Zhiyun
Published: 2009-06-01

Cover story
Original article: [Chinese]

Fund raising problems amongst local governments have not only impeded investment projects under China's 4-trillion yuan stimulus package, they also may have laid debt bomb for local administrations, two major Chinese agencies warned.

Latest findings by China National Audit Office (NAO) revealed the central government had released 94% of the funding earmarked for 335 new projects by late March, but some local governments could not match their share of contributions timely, causing delays in projects' implementation.

The NAO also disclosed that some funding failed to enter the real economy.

Meanwhile, China Banking Regulatory Commission (CBRC) recently issued a notice to Chinese trust companies and commercial banks, warning future credit risks and calling for prudence in financing local government-led projects.

The CBRC ordered comprehension assessment against local governments' fiscal capacity, liabilities scale, and credit rating prior to approving funding.

Pressure on Local Governments

The above assertions came against the backdrop of rapid credit expansion - new loans released in the first four months of 2009 reached 5.17 trillion yuan. As a result, concerns over bad debts and risk control have grown along the rising new lending.

Under China's 4-trillion-yuan stimulus package arrangements, local governments were required to contribute 2.82 trillion yuan of funding, while the remainder offered by the central government.

The NAO conducted a survey in 18 provinces lately and in a report released on May 18, it revealed that some local governments had lagged in channeling the required funding timely, with the poorest performing province managed to release only 48% of the funding earmarked.

The Economic Observer learned that majority of the local funding came from policy-driven bank loans, while local bonds - by late April, 111.8 billion yuan worth of bonds issued - and contributions from local treasuries formed a minor part of the financing. Meanwhile, participation from private capital was negligible. 

For locally initiated investment projects, even if bank loans were secured, the local governments concerned would need to raise the required registered capital, which constituted some 20% to 40% of the projects' cost. 

Sources from the banking industry and local authorities told the EO that red tape and shrinking local revenues - resulted partly from tax cuts to stimulate the economy and reduced collections from less profitable companies - had added pressure to timely financing from local governments.

A state-owned bank researcher estimated that the grand total of local financing required - including that for projects mapped out under the stimulus package and other supplementary costs - could run into 5.2 trillion yuan, nearly double that of all the local treasuries' revenues combined - 2.8 trillion yuan - last year. 

Financing Risks
After the stimulus measures kicked off, Chinese banks, especially the major state-owned ones, have been supportive of government-led projects - evident in the surge of new lending this year.

The EO learned that since March, the joint-stock banks - which formed the second tier of Chinese banking system - had also joined in the race, courting trust companies to channel loans for local government-led stimulus projects.

"In previous years, we used to only grant loans to provincial capital cities related investment projects, but now, loans are easily available for secondary or third-tier cities," said a credit issuer at a joint-stock bank. The source added: "banks are now competing with each other to provide loans to local authorities."

China's banking watchdog, however, had stepped in to prevent overly vigorous and carefree lending. The EO learned that the CBRC had ordered trust companies and banks to re-evaluate their co-operations with local governments.

The CBRC wanted to ensure that loan approvals were based on a thorough check against the fiscal strength and repayment ability of local governments.

A source from the CBRC told the EO: "The main risk lies in inadequate registered capital from local governments in starting up a project."

The above source added that some local government-led projects had few potential for generating profits, thus increasing risk for debt repayment.

To relieve financing pressure at local level in meeting the required registered capital for investment projects, the EO learned that Chinese Finance Ministry was planning to expand local government bonds issuance in the first half of 2009.

In addition, the government would also encourage financially sound companies to raise funds through corporate bonds in support of local government-led projects.

Wen Huishu also contributed to this article.
Translated by Liu Peng