A little local difficulty
China is being a bit more precise about its debt problem. A long-awaited audit of local government borrowing shows that provinces, towns and villages collectively owed 17.9 trillion yuan ($2.96 trillion) at the end of June, including contingent liabilities. The state will now have to decide which of those debts it wants to stand behind. Its approach will offer some hints about the importance of leverage for China’s economic growth.
On the face of it, the National Audit Office’s (NAO) report offers no immediate cause for alarm. Though local debt has expanded, total government borrowing at the end of 2012 was less than 40 percent of GDP. True, this excludes contingent liabilities and the debts of China’s former railway ministry. But it remains a fraction of burdens carried by governments in the developed world.
Yet this analysis skates over several issues. The first is that local government debt has grown very quickly. The NAO admits that cities and councils have increased their borrowing at an annual rate of almost 20 percent since the end of 2010. Second, much of that debt is short-term: more than 40 percent of the local borrowing is due to be repaid before the end of 2014. Debts worth more than 1 trillion yuan were actually overdue at the end of June.
Of course, identifying the problem is not the same as tackling it. As they have done in the past, Chinese leaders could turn a blind eye, encouraging banks and other lenders to keep rolling over their loans. But that would only encourage local authorities to find creative new ways to borrow with the implicit promise that the central government will never allow them to default.
If the leadership is serious about giving market forces a greater role in pricing credit, it will have to decide which debts it wants to support, and which ones it is willing to cut loose. Hanging over that potentially messy process is a broader question: to what extent is China’s economic growth dependent on ever-increasing amounts of leverage? The country’s willingness to tackle local government borrowing will offer some clues.