Deutsche Bank Research published its Asia Economics Monthly report last week, and the issue highlighted a feature story on Chinese local government financing. DB analysts Taimur Baig et al point out that overall government debt in China has grown significantly since 2008, and that local debt was the fastest growing category of Chinese government debt.
Growth in Chinese government debt
Chinese government debt is growing rapidly. According to the Chinese National Audit Office, total government debt increased by around 9% in 2013 compared to 2012. Among this total government debt, central government debt was up 4.2%, and total local government debt was up 12.6% from 2012. Furthermore, local government debt is up a whopping 67% since year-end 2010.
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China: Local debt is higher percentage direct debt
The Deutsche Bank report also highlights that local debt is more direct debt than contingent debt. “Local government debt with direct repayment obligations seems to be concentrated at the city and county levels, which accounted for 45% and 36% respectively of direct local government debt.”
Implicit debt guarantees
It should be noted that the Chinese local government financing system is clearly hierarchical, and that higher level local government is implicitly responsible for backing the debt of lower-level local government. “This suggests that (a) China’s local government creditworthiness is positively correlated with the level of the local government (i.e. higher-level government is perceived as more creditworthy); and (b) structurally higher level local government is responsible for bailing out lower level government by honoring the debt guarantee.”
Local government financing vehicles are a potential problem
Baig and colleagues focus on local government financing vehicles (LGFVs) as the weakest link the Chinese local government debt chain. More than 38% of the total outstanding direct local government debt is borrowed by LGVFs, government agencies have a 28% share, institutions with expenditure subsidies represent 16% and SOEs another 11%. LGFVs, government agencies and SOEs all also hold large contingent debt positions.
The DB report explains the size of this not-directly-backed LGFV debt could be a major drag on the balance sheets of China banks in the medium to long-term. “These LGFV loans are a major concern among investors in relation to the underlying quality of banks’ loan portfolios.”