China is in the midst of a property bubble fueled by a shadow banking system and local political corruption. The meeting of crises will, according to some of the biggest investors out there, result in a financial crisis at some time in the future. A new analysis from ANZ Research disputes that conclusion, arguing that large scale privatization, among other changes, will save the country.

China's shadow banking

The ANZ Research note, which was authored by Li-Gang Liu, Hao Zhou, and Louis Lam, argues that debt levels at China’s local government institutions have been overblown, and there is less of a risk of default than has been assumed. In order to avoid the default, however, China needs structural change.

Assets outweigh liabilities

One of the biggest problems in dealing with China, as always, is trying to find adequate proxies for the statistics needed in a model. ANZ uses a framework developed by China Academy of Social Science and the National Bureau of Statistics in order to estimate the asset and liabilities levels in China.

According to the results of that model, China’ local governments still hold much more assets than they do debt. Total assets estimated owned by local governments are at CNY38trn, while liabilities come in at CNY15trn. That leaves a cushion for debt repayment.

There are a couple of caveats that come with this model. First off, it’s just an estimation of the assets and liabilities of Chinese government institutions. Second, assets can be very difficult to measure. If China does enter into a crisis of some kind, those asset values could shrink considerably.

Change needed to save China

Regardless of measurement difficulties, the conclusion of the report is that local Chinese governments are able to pay off their debts, if they are willing to sell off large parts of their assets in order to do so. That means a big change in China, and one that caused its fair share of problems in the Western world during the 20th century.

China’s local governments are not actually allowed to issue bonds, so they take on debt using corporation specifically designed for the purpose. Those corporations may be let collapse if servicing the debt becomes too expensive, and there is not government guarantee of the bonds issues by them.

China has started to look at other ways for its local governments to pay for shortfalls, with old fashioned municipal bonds being floated as a possible solution, but that doesn’t do much for the neat CNY1trn in bonds sold by local governments last year through the shadow banking system.

China privatization is not an easy answer

Chinese local government may have more assets than debt, but that may not avert financial collapse. Privatization is a difficult process that can have untold effects on the economy. It cannot all be done in six months, unless economic collapse is the desired goal.

If privatization is the answer to China’s debt problem, a privatization plan will have to be put together soon. If local governments begin to default on their debt it could cause a knock on effect that drastically reduces the value of assets in the country and makes privatization almost impossible.

China is a massively complicated country with little in the way of statistical evidence to support moves in one direction or the other. The Asian giant is simply so big and ineffable that nobody knows what a financial crisis there would look like, or how the country’s government might respond.

That makes privatization a difficult saviour, and one not to be relied on.