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China Orders Local Governments to Set Up Debt Repayment Funds

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Source: Reuters

China’s local governments should set up special funds to repay some of the RMB10.7-trillion (US$1.7-trillion) debt they owe and must use all their fiscal resources to do a “good job” in paying their creditors, Finance Minister Xie Xuren said on Tuesday.

Xie said China would continue to take measures to ensure debt risks are under control and that Beijing was considering incorporating debts of its local governments into the national budget.

“Various local governments need to set up debt repayment funds to use all their fiscal resources available to repay their debts,” Xie told a news conference on the sidelines of China’s annual parliamentary meeting, the National People’s Congress.

“We ordered local governments to do a good job in repaying their debts.”

Xie did not elaborate on how debt repayment funds would work, or what the impact would be if Beijing were to include local government debt in the national budget.

Nor did he define what “all fiscal resources” encompassed, a vital point for investors speculating that China will force local authorities to privatise or securitise assets to repay debts run-up on infrastructure built at Beijing’s behest to boost economic growth after the 2008/09 financial crisis.

Liu Qiao, a professor at Peking University’s Guanghua School of Management, said the central government could be considering a type of securitisation where local authorities package debt and issue bonds based on it.

“Maybe it’s on a case-by-case basis to work it out. If there’s a huge gap, the central government will do something. But they first need to make sure which (debts) can be paid back,” Liu told Reuters.

“The central government is asking the local governments to closely monitor and see what they can pay. If they need help, they will need to justify it. The central government would be a last resort,” Liu said.

Many analysts believe local government debt could threaten China’s banks if cash-strapped local governments default and saddle them with a stock of sour loans.

As banks supplied most of the local government loans, a domino effect could put overall financial system stability at risk in a worst case scenario.

Although China’s local debt woes have festered for over a year, Beijing has offered few details on the extent of the problem or possible solutions.

The lack of information led some analysts to guess at least a fifth of loans, worth RMB2-3 trillion, have gone bad. They say that could cause banks’ non-performing loan ratios to more than quadruple to about 5 per cent.

But the head of China’s biggest bank said on Tuesday that the lion’s share of its local government loans are doing well and are backed by adequate cash flows.

Analysts expect state banks will roll over much of what is owed by local governments rather than report them as sour loans on their balance sheets.

HSBC estimates China’s debt burden is still manageable at 55 per cent of GDP, but says the rub is in the cash shortage faced by local governments that could cause “a major bank default”.

Faster privatisation would save banks from bad loans that can easily quintuple or more, analysts say.