China Audit Office Shines Light On Local Government Debt

June 11, 2013, 5:56 PM

Audit Office Shines Light On Local Government Debt

In recent years, China’s local governments have borrowed trillions of yuan from banks, the bond market andshadow lenders in order to build infrastructure, housing, and improve government services. That spending has helped prop up economic growth, but little is known about the quality of debt and the local governments’ ability to repay it.

On Monday, the National Audit Office of the People’s Republic of China posted on its website the highlights of an audit into the debt holdings of 36 local governments at the end of 2012, providing rare insight into one of the greater challenges facing China’s financial system.The audit report was a huge undertaking, covering 223 local government financing vehicles, 1,249 institutions backed by local government funding, 903 government agencies and departments and more than 22,000 projects.

It included the governments of 15 provinces and their provincial capitals, as well Shanghai, Tianjin, and Chongqing, some of the biggest cities in the country. It also included three district governments that fall underneath Shanghai, Tianjin and Chongqing.

While local governments can’t borrow funds themselves, they typically get around those restrictions by having government backed investment platforms – called local government financing vehicles – or quasi-government agencies borrow instead. The local government is still indirectly responsible for the debts, however.

The audit found that the 36 governments had taken on debt totaling 3.85 trillion yuan ($624.6 billion) as of the end of last year, up 12.9% from the end of 2010. The last such audit measured local government debt as of the end of 2010.

The audit office said there had been some improvements since the end of 2010, with 24 governments having posted a reduction in their debt levels relative to their total fiscal resources. But it also said that the outstanding debt of nine provincial capitals at the end of 2012 was greater than their fiscal resources, with the level of one city reaching almost 190%, a level that rises to 220% if you take into account promises the government had made to guarantee the debts of other institutions.

The report also said that the interest and principal on loans that needed to be repaid at the end of last year by 13 provincial capitals – out of 15 in the sample – was equivalent to 20% of their fiscal resources, with the level reaching as high as nearly 68% for one unnamed city. Analysts say that in recent years, revenue for many local governments haven’t been enough to cover ordinary expenses such as wages and services, let alone debt repayments. At the beginning of the year, cities and towns around the country complained in their annual work reports that they were struggling to balance their budgets.

Monday’s audit report said local governments’ fiscal problems were being exacerbated by declining revenue from land sales, which many local governments had pledged to cover their debts, and that local governments have increasingly turned to non-traditional sources of finance – trust companies, leasing firms, wealth management products, and even illegal fundraising – as new loans from banks have become increasingly difficult to come by.

“Because they don’t have the capacity to repay their loans, some provincial capitals have no choice but to raise new debt to repay maturing loans,” the report said, adding that five towns in the survey raised new debt to repay more than 20% of their debts last year. It said that more than 10% of the debt owed by two provincial capitals at the end of last year was in default, without naming those cities.

The report also expressed concern about local government financing vehicles – responsible for funding much of the infrastructure built at a local level – which accounted for 45.7% of the total debt of the local governments covered by the audit. The report said that at the end of last year, the income of 151 financing vehicles out of the total 223 covered by the report was insufficient to cover interest and principle repayments, and that 37 had posted losses.

It is hard to tell how representative the survey is of local government debt. Given that the audit office found total outstanding local government debt at the end of 2010 stood at 10.7 trillion yuan, Monday’s report probably represents 25% to 30% of China’s current local government debt picture, which should be a fair sample.

But the survey covers only the country’s biggest and financially most stable provinces and cities. Many towns below the provincial capital level have also been borrowing aggressively over the last couple of years, but are less fiscally robust and so have not been permitted to tap the bond market. Instead, they have turned to trust companies and wealth management products where interest rates are much higher, which could make it more difficult for them to repay their debts.

Still, the audit office’s report clearly flags that China’s local governments are feeling the pressure. The risk is that if left unchecked, that stress could migrate to the banks and the financial sector more broadly.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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