Is local government debt a serious threat to the Chinese state?

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Diana Tan's picture

According to recent reports by both the Chinese Government and investment bank, UBS, total local government debt in 2011 was $2.2 trillion- almost equivalent to a third of the GDP of China and considered to be an ever increasing value. This value could generate $460 billion in loan defaults that rival the $700 troubled asset bailout program ad serve as an insurmountable liability for the Chinese government in addition to the $2 trillion debt already in place (Barboza, 2011).  This value serves as a huge concern for the further development of the Chinese economy as well as a lingering threat to the central government who may be challenged by loan defaults in the future. The sources of the expenses as well as the current transactions conducted by the Chinese government to incur such debt are huge factors in determining the potential threat.

One of the main reasons local municipal government debt is incurred is due to infrastructure and land - in part due to the wishful thinking of many local governments. In Wuhan, with a 57 billion dollar subway system as well as numerous shopping malls, expressways and buildings, Wuhan expected to draw metropolitan enterprises in order to grow despite its inland location.  This year, 22 billion dollars was planned to be spent on infrastructure projects alone, an amount that was five times the amount of revenue the city takes in. This was compounded by existing debt, which Wuhan then borrowed $230 million from investors in order to pay (Barboza, 2011). This has created speculation that ballooning interest and using debt to pay previous debt may be another obstacle.  This debt cycle perpetuates the threat of defaulting on debt and balloons existing debt to proportions that Chinese growth may not be able to match.

Another issue is that expectations of the products of local municipal debt. Many bonds issued were based on the local “forecast” that the value of land would increase dramatically with development. This was seen in Loudi, Cangzou and Yinchun. In Loudi, $185 million in bonds was issued to create an Olympic sized complex, swimming pools and other structures designed to attract large scale production and development. However, this has generated negative 30 million in revenue with no defined cash flow to generate more revenue. At the same time, the value of the bonds was guaranteed by the cost of the land, which was considered to be 4x the actual price the previous year. In Cangzou, 155 million in bonds was issued in order to build “green projects” that were unspecified with a high debt to revenue ratio; while in Yinchun, bonds were backed by no collateral, only a pledge from the central government. The myth of the land values is compounded by the fact that residential land values actually slumped 30% (Sanderson, 2011). This shows the unrealistic expectations associated with spending municipal debt in order to develop cities and municipalities that may never generate revenue. With no collateral and high valuation of the land and city infrastructure, this also shows the high risk of the cities of defaulting on debt because of low revenue in what is considered China’s largest “boom” stage. The failure of the cities to develop and attract investments to create revenue would cause a 155 million dollar default in Cangzou, collecting on what would be considered significantly less valuable or essentially worthless land.

This debt will also serve as a continuous threat to the Chinese state due to how it is managed and obtained in the first place and the fact that enforcement of municipal measures to curtail these practices of issuing debt has been absent. While Beijing has traditionally prohibited municipalities from issuing debt for government projects in the first place, many transactions have been “off the books” or done with encouragement of sorts under the guise of development. In the current Chinese political environment, many municipal officials can utilize projects to increase short term gain and therefore receive promotions and bonuses based off of attracting new projects. Local government officials believe that they can receive recognition and compete with neighboring provinces in addition to personal financial gain from increasing the value of their own land or receiving funding from contracting organizations (Barboza, 2011). This system has created additional incentive to over-value assets to develop as well as to perpetuate the ongoing threat.

In comparison to other countries, China has a higher spending on infrastructure (70%) than Japan (35%) at its peak and the United States (20%) with higher expectations of growth (Barboza, 2011). However, as seen in Japan and the United States, growth eventually stagnated. In a recession economy, this creates additional speculation and fear that China’s growth is not sustainable and the additional spending will become a burden for future generations.

In conclusion, China’s municipal debt poses a huge threat for the United States given the current status of many of the infrastructure and government based expansion projects which are overvalued with high expectations and high risk. Current costs have already spiraled to include heavy borrowing to repay exist debts and interest as well as potential defaults on projects in inland and possibly worthless areas which may never recognize necessary revenue. While China does have the funding from foreign reserves, unless China can create enough growth in other areas to repay and sustain municipal government debt for these projects and curtail future development of these issues, municipal debt can be a crippling experience that harms China’s ability to stabilize long term. 

References: 
  1. Barboza, D. (2011, July 6). Building boom in china stirs fears of debt overload. New York Times, Retrieved from http://www.nytimes.com/2011/07/07/business/global/building-binge-by-chinas-cities-threatens-countrys-economic-boom.html?pagewanted=all
  2. Sanderson, H. (2011, July 13). China cities value land at winnetka prices with bonds seen toxic. Bloomberg News, Retrieved from http://www.bloomberg.com/news/2011-07-13/china-cities-sell-land-at-winnetka-values-with-bonds-seen-toxic.html