Local government debt unnerves Chinese accountants

Wobbly GDP figures have already caused alarm about the prospects for the Chinese economy, but a number of senior organisations are looking at local government debt and finding further cause for concern.

Last week, Beijing announced that growth in the world’s second-largest economy had slowed to 7.7 per cent in the first quarter, lower than market expectations.

But perhaps there is worse in store. In a report in the Financial Times last week, a senior Chinese auditor warned that local government debt was "out of control" and said that it could spark a bigger financial crisis than the US housing market crash.

Zhang Ke said his accounting firm, ShineWing, had all but stopped signing off on bond sales by local governments as a result of his fears.

"We audited some local government bond issues and found them very dangerous, so we pulled out," said Zhang, who also happens to be vice-
chairman of China's accounting association. "Most don't have strong debt servicing abilities. Things could become very serious.

“It is already out of control,” said Zhang. “A crisis is possible. But since the debt is being rolled over and is long-term, the timing of its explosion is uncertain.”

He is not alone in being concerned about this.

A lack of clarity about government debt, combined with fast bank lending growth and the slow pace of economic reform, were among the factors prompting the ratings agency Moody’s to cut China’s credit outlook to stable from positive last week.

Risks from China’s local government liabilities could “derail the transition to a more balanced and more moderately growing economy”, the agency said.

Fellow credit agency Fitch also warned of local governments’ high exposure to bad debts when it recently downgraded China’s long-term local-currency rating from AA-minus to A-plus.

Local governments are prohibited from directly raising debt, so they have used special purpose vehicles to circumvent these rules, issuing bonds under the vehicles’ names to fund infrastructure projects.

Bonds issued by these government- owned investment companies generally receive top-tier credit ratings from domestic agencies because they are seen as being guaranteed by the provinces and cities that back them.

Investment companies owned by local governments sold 283 billion yuan (€35 billion) worth of bonds in the first quarter of 2013, more than double the total for the same period last year.

Hu Shuli, the editor-in-chief of the Caixin Media Company, and one of the country’s most respected commentators, said the government needed to rein in credit creation, properly audit the accounts and require more transparency in an overhaul of the regulatory regime.

The central bank should lead the new regulatory regime, and facilitate co-operation and information sharing such as with the China Banking Regulatory Commission.

Just how big is the debt? According to the National Audit Office, local governments including provinces, cities, counties and villages had 10.7 trillion yuan (€1.33 trillion) of debt at the end of 2010, which is about 27 per cent of the
economy that year. Others say it could be twice that.

The National People’s Congress budget report, meanwhile, said principal repayment of local government bonds last year totalled 200 billion yuan (€24.8 billion). Some experts estimated a rise last year of 1-2 trillion yuan (€120-240 trillion). Even based on conservative estimates, local government debt may now exceed 12 trillion yuan (€1.5 trillion).

“This debt is worrying not only because of its size. Worse, it is not transparent and we don’t know how it will be handled. Of particular concern is the tendency of Chinese officials to let political expediency override economic sense,” said Hu.