Cut the cord, before China’s municipal gov’ts strangle themselves

Cut the cord, before China’s municipal gov’ts strangle themselves

Gregory Chow

2013-08-26

Many questions have arisen on the huge accumulation of debt by China’s municipal governments, including: What is its specific amount? What are its reasons? Is it a serious problem? How to solve it? The total debt of China’s municipal governments is estimated at 14 trillion yuan (US$2.3 trillion), 30% of its national income of 48 trillion yuan (US$7.8 trillion), compared with the share of 14.4% of the central government’s debt. As a result, the Chinese government’s total debt amounts to 44% of the national income, far below the 100% of the US government’s debt, which is not a serious problem in the eyes of most American people, especially Democrats.Still, the Chinese government’s debt is a serious problem. Municipal governments have questionable resources for repaying it and they are plagued by poor efficiency in utilizing the economic resources obtained through debt. In addition, creditors, including American people and foreign governments, have confidence in the US government, but China’s municipal governments often default on debts, mostly in the form of bank loans borrowed through state enterprises. The credit standing of China’s central government is good, since its debt is not high and it owns sufficient financial income to repay its debt.

China’s municipal governments often borrow money, mostly from state banks, via the front of dedicated units or government enterprises. They use the loans to fund development projects and subsidize specific industries, such as solar energy. In many cases, they do not bother to repay what they have borrowed.

Failure to repay the debt could undermine the credibility of municipal governments, making it difficult for them to borrow again. In addition, financial waste would only further damage any willingness to loan, and could possibly end up destabilizing China’s banks with an overload of bad loans. On the other hand, if the loans are utilized efficiently, such as in the construction of high-speed railway lines and other infrastructure projects, it can prevent a global financial crisis.

To solve the problem, some suggest the central government strictly control debts of municipal governments, but many question their ability to exercise control.

Since all municipal government loans are borrowed from banks, a more effective solution is the improvement of banking operations. Despite the reform of China’s economic system starting from 1978, Chinese banks have retained outdated practices, a legacy of the planned economy era. State loans are not evaluated from an economically feasible perspective.

Bad loans have not become a serious problem thanks to the government’s guarantee to repay banks. In addition, the central government has set up an Administrative Bureau of State-Owned Properties to purchase non-performing loans. This does not make it a wise decision to allow banks to extend loans freely.

In order to cope with NPLs and bad debt from municipal governments, it is necessary to restrict bank loan extensions, a practice indispensible for a normal banking system, such as that in the US and Hong Kong.

The finances of Chinese banks must be independent, under the supervision of the central bank. Under independent finance, bank employees would carefully consider their interests and losses, as excessive loans would subject banks to a financial crisis. Loans extended to unqualified projects would jeopardize the interest of banks and their staff.

Without the considerations of the interests of their staff, banks extend loans based upon their network of connections within the private and government sectors, even at a loss. One method to prevent the malpractice is to require banks to issue shares, giving the public a majority stake and an elected board of directors control of selecting bank managers.

Under a well-run banking system, the central bank and other financial management authorities can adjust reserve funds held by commercial banks and restrict their loan extensions. Such a banking system can help banks effectively allocate their financial resources, to safeguard the interest of banking employees, in addition to facilitating the adjustment of the macroeconomy through monetary policy and the reduction of economic fluctuation. It can also help state enterprises and municipal governments cut bad debt and effectively utilize economic resources.

(The author is member of Acamedia Sinica in Taiwan and professor emeritus of Princeton University.)