China: Tackling the Local Debt Problem Head-On?


Chinese financial and economic authorities are planning a bailout package for the country’s heavily indebted local governments, according to a Reuters report. Details resemble a Finance Ministry plan announced in March 2010, but the leak suggests that grave debates are under way among China’s leaders about how to manage growing risks to financial stability before the leadership transition in 2012.

According to the May 31 Reuters report, Beijing’s investigation concluded that local governments had accumulated a tally of 10 trillion yuan worth of debt, and that about 2 trillion (or 20 percent) of it was expected to go bad, roughly in line with the earlier CBRC estimate. Consequently, the CBRC, along with the Ministry of Finance, the National Development and Reform Commission, and presumably the central bank and other bodies, are planning a combination of measures to address the problem. These include:

    Two to three trillion yuan worth of debt would be transferred from local governments to major state-owned banks.
    The central government would shoulder some of the burden by paying off loans and taking debt onto its books.
    State-owned banks, including some of the top four state-owned commercial banks, would have to write off an unspecified amount of the bad debt and accept losses.
    Provincial and municipal governments would be granted legal permission to issue bonds to cover debts and finance projects going forward.
    The government would oversee an entire overhaul and consolidation of the LGFVs.
    The report also referred vaguely to “new” companies that would be set up to accept some of the debt transfers, perhaps asset management companies. It also spoke of new allowances for private investors to invest in areas in which they were previously not allowed invest, though it was unclear whether this would be to purchase debt or to finance future economic projects.
    The plan is expected to be implemented in June and completed by September, though one source said it could take longer.

All that can be determined at present is that a bailout plan for local governments is still being discussed. Are China’s leaders debating this now because they believe that with the global recovery continuing and more than $3 trillion in foreign exchange reserves, they have the advantage? Or are they being forced to tackle the problem now because of exigencies related to the slowing pace of economic growth and extensive systemic financial risks? If a bailout is implemented in this time frame, the extent to which Beijing will use its cash surpluses for recapitalizations is unclear. Moreover, it remains to be seen whether it will attack financial problems directly or merely use expedients to preserve financial stability in the short term, even at the cost of building up greater risk in the long term.

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