Transparency the crux in China’s struggle to deal with rising debt; Fears after key China debt level soars 70% to $3 trillion

Last updated: December 30, 2013 7:36 pm

Fears after key China debt level soars 70%

By Tom Mitchell in Beijing

Local government debt levels in China have soared to almost $3tn in less than three years, according to an official audit highlighting one of Beijing’s most daunting challenges as it attempts to sustain economic growth while avoiding a financial crisis.In a long-awaited report, China’s National Audit Office said local government debts had increased almost 70 per cent to reach Rmb17.9tn ($2.95tn) by the end of June. The NAO, whose last survey put the burden at Rmb10.7tn at the end of 2010, added that government debt levels were generally “under control” but identified “potential risks in some places”.

Monday’s audit, which included contingent liabilities and debt guarantees, was ordered by the State Council in June. Xiang Huaicheng, former finance minister, had previously estimated that local government debts could exceed Rmb20tn.

Chinese officials and analysts have long worried about the amount of debt racked up by local governments, which are not allowed to tap banks directly but establish special purpose vehicles to borrow money for investment projects. Such borrowing, often secured against local land values, helped China achieve impressive rates of growth even in the immediate aftermath of the global financial crisis

There are increasing fears, however, of a hard landing for the economy as Beijing enforces fiscal discipline on local government borrowers. China’s short-term funding costs approached 9 per cent earlier this month, before moderating towards the end of last week.

Speaking at the weekend, Chinese premier Li Keqiang said his government would guarantee “appropriate liquidity” and “reasonable growth in credit” next year. In a recent report to China’s parliament, the State Council predicted a final GDP growth figure of 7.6 per cent for 2013, compared to 7.7 per cent last year and a post-crisis high of 10.4 per cent in 2010.

The NAO’s latest estimate for local government debt is equivalent to a little more than 30 per cent of gross domestic product, compared to 25 per cent of GDP at the end of 2010. “The pace of [local government] debt accumulation in recent years has been too fast and is not sustainable,” said Wang Tao, economist at UBS.

According to Ting Lu, economist at Bank of America Merrill Lynch, China’s total public debt now stands at 53.3 per cent, with corporate debt estimated at 111 per cent.

“The markets and the Chinese government should be alarmed by the rapidly rising leverage,” Mr Lu said in a note. “But we do not believe China is on the brink of a debt crisis, especially if the new leaders can take decisive measures to arrest rising leverage.”

“The number is pretty much in line with expectations,” added Arthur Kroeber at GK Dragonomics. “The starting point in terms of managing it is stopping a new flow of local government debt.”

Bo Zhuang, economist at consultancy Trusted Sources, said that unlike its earlier audit, Monday’s NAO report had included a survey of village governments. He added that central government officials were particularly worried about the value of land pledged as loan collateral in China’s smaller cities.

Zhang Ke, a senior Chinese auditor, warned in April that local government borrowing was “out of control” and could spark a massive financial crisis.

December 30, 2013

China Says Local-Level Debt Soars, Stirring Fear


HONG KONG — The total debt of local governments in China has soared to nearly $3 trillion as the country’s addiction to credit-fueled growth has deepened in recent years, according to the findings of a long-awaited report released on Monday by the central auditing agency.

In the report, which is likely to further raise concerns about China’s debt problem, the National Audit Office found that local governments across the country had accumulated 17.89 trillion renminbi, or $2.95 trillion, worth of debt obligations as of the end of June. That was an increase of 12.7 percent from December 2012, when local government debt stood at 15.88 trillion renminbi, the report said.

The June figure also represented a sharp increase of 67 percent from the end of 2010, when an earlier report by the Audit Office estimated local government debt at 10.71 trillion renminbi.

Other reports have estimated local government debt at significantly higher levels, including one issued last week by the Chinese Academy of Social Sciences, a government-linked research institute, which put the figure at about $3.3 trillion.

In the five years since the onset of the global financial crisis, local governments at the provincial, municipal, county and township levels across China have gone on a spending spree, loading up on debt to finance a surge of investment in infrastructure, real estate and other projects.

Analysts have expressed fears that many of these investments may never make enough money to repay the interest and principal on the debt.

The structure of much of this borrowing has also raised concerns. With a few exceptions for pilot programs, local governments in China are prohibited from directly taking on loans or issuing bonds. Instead, they have set up thousands of special-purpose financing vehicles that borrow on the government’s behalf to pay for a given project.

Such financing vehicles had confirmed probable and potential debt obligations totaling 6.96 trillion renminbi as of June, according to the Audit Office’s report, accounting for nearly 40 percent of all local government debt.

Analysts had for months been anticipating the results of the audit office’s survey. As part of an investigation that began in July, the agency said, it deployed 54,000 auditors across the country, who combed through the books of more than 62,000 government departments and institutions and examined 3.4 million debt instruments related to more than 700,000 projects.

Including financial obligations on the national level, the audit office report found that China’s total government debt stood at 30.27 trillion renminbi at the end of June, up from 27.77 trillion renminbi in December 2012.

Based on findings of the new report, Lu Ting, a China economist at Bank of America’s Merrill Lynch unit, estimated that China’s total public debt stood at 53 percent of gross domestic product. Adding corporate and household obligations lifts the total debt ratio to as much as 190 percent of G.D.P., he estimated.

China’s overall debt ratio “is neither exceptionally high nor low,” Mr. Lu wrote on Monday in a research note. Still, he said he was concerned that for the last two years China has been adding debt faster than its economy has been growing.

“We believe the markets and the Chinese government should be alarmed by the rapidly rising leverage, but we do not believe China is on the brink of a debt crisis, especially if the new leaders can take decisive measures to arrest its rising leverage,” Mr. Lu wrote.

Under President Xi Jinping, the Chinese leadership has promised to deliver reforms that will be the country’s most ambitious financial overhauls in decades. Mr. Xi will head a group that will steer economic and social reforms, Xinhua, the state-run news agency, said on Monday.


December 31, 2013 3:12 am

China confident that it aced local debt audit examination

By Simon Rabinovitch in Shanghai

If the Chinese government is embarrassed about its debt burden, it is doing a good job of hiding its blushes. Like a student showing off a stellar report card, Beijing is filling its newspapers and airwaves with the results of the most exhaustive audit of the country’s public debt.

While many analysts focused on the big rise in borrowing by local governments, the official line in Beijing is that China has scored top marks in the examination.

On Monday, the Chinese government revealed the results of an exhaustive audit of the country’s public debt, showing that local government liabilities have risen to $3tn, up sharply over the past two years. What is Beijing’s assessment of the situation?

The government said it was concerned about theincrease in debt

, especially at the village and township levels. But its main message was that Chinese public debt was well under control and extremely low by international standards.

Whether analysts and investors agree with that assessment or not, it is essential for them to appreciate that Beijing has emerged more confident, not more panicked, from the debt audit. This comes across clearly on three fronts.

How quickly have China’s debts increased?

Almost all reports pointed to Rmb17.9tn ($2.95bn) as the new level of local government debt by the end of June, up 70 per cent from the Rmb10.7tn figure calculated by the national audit office for the end of 2010.

But China’s National Audit Office itself presents a different number. Since it added villages to this audit – the last audit only went down to towns – additional debts have been thrown into the mix. On a purely apples-with-apples comparison, the audit office said local debts had increased about 35 per cent since the end of 2010, still a big increase but half as fast as suggested by the headline figure.

How big is China’s real debt load?

The audit’s full tally for Chinese public debt across all levels of government is Rmb30.3tn, or nearly 55 per cent of gross domestic product. But the NAO was at pains to emphasise that the Rmb30.3tn figure included Rmb9.6tn of contingent liabilities, and argued that these cannot be viewed as straightforward debts.

The audit office estimated that in a worst-case scenario, the government would only have to cover about one-fifth of these contingent liabilities, which include the debts of government-owned financing vehicles, schools and hospitals.

On this basis, the NAO said that China’s actual public debt is slightly more than Rmb20tn, or 39 per cent of GDP. Noting that this is well below that of the US, Japan and most European countries, Jia Kang, head of a research institute under the finance ministry, told state media that China’s debts “are definitely in a safe zone”.

How rigorous was the audit?

For those disinclined to trust Chinese economic data, the audit has not led to a change of heart. Instead, it has provoked more scepticism: if the government is fessing up to this much debt, the true hole must be enormous.

Yet in Beijing, the belief is that this debt audit – the third in three years – is the most detailed and accurate measure of the problem. Ma Xiaofang, vice head of the department leading the government debt audit, noted that 50,000 officials had worked over the past half year, with higher levels of government checking on lower levels. “This system ensured that our audit did not encounter interference, that our audit figures are real and reliable,” he told state broadcaster CCTV.

What are the flaws in the government’s official narrative about China’s debt burden?

Most crucially, the major concern for China is not government debt, but rather corporate debt, which has surged to more than 100 per cent of GDP, unusually high by international standards. This did not show up as a contingent liability in the audit, but Chinese governments have consistently stood behind failing local champions, whether state-owned or private, meaning that many corporate debts could yet end up as public debts.

The audit was initially scheduled to be published in October or November and the delay has raised concern among some Chinese analysts and academics that the results have been subject to political interference and massaged to present a rosier picture of the problem.

In late August a senior Chinese official with responsibility for setting economic policy told the Financial Times that total government debt “definitely did not exceed 40 per cent of GDP”. The audit results published by the government on Monday showed that total government debt, not counting contingent liabilities, at the end of 2012 equalled 39.43 per cent of China’s GDP.

The audit also highlighted a worrying pattern of debt rollovers in China. It noted that 60 per cent of debt will mature before the end of 2015. However, according to the 2010 audit, more than 60 per cent of debt was to mature before the end of this year. The upshot is that the vast majority of the debt has not been retired but just refinanced to put off the reckoning for another day.

That strategy has worked well so long as China has been able to outgrow its debt. Over the past few years, though, Chinese debt has expanded more quickly than growth – a statement that is true even if taking the more restrictive definitions of public debt favoured by the national audit office.

Beijing may well be right to declare that its current stock of debt is no cause for alarm. But if that confidence breeds complacency, China’s next debt audit will make for much more uncomfortable reading.

Transparency the crux in China’s struggle to deal with rising debt

4:24am EST

By Koh Gui Qing

BEIJING (Reuters) – China’s quest to solve its $3 trillion-and-growing public debt problem by starting a domestic municipal bond market hinges on the one thing its officials are most afraid of: transparency. As markets absorb the results of China’s latest audit of its state finances, Beijing’s long-standing vow to develop a municipal bond market to curtail rapid growth in other types of hidden public debt will take centerstage once more.

By letting local governments sell bonds for cash, China wants to rely on nimble markets rather than inflexible regulations to keep spendthrift units in check.

The stakes are high. A bond market is the centerpiece in China’s blueprint to mop up fiscal troubles and keep its economy growing at an even pace, giving it needed room to start other bold financial reforms.

But analysts say China’s dreams of a municipal bond market are so far just that, as building one has been impeded by a lack of disclosure from local governments on how much money and assets they have, and how much they owe.

“If you want to lend to a specific government, you need to have a clue as to what the financial conditions are like,” said Tan Kim Eng, a senior director of sovereign ratings at Standard & Poor’s in Singapore.

“There’s still a lot of work to be done on the fiscal transparency front.”


In the meantime, some investors are increasingly alarmed by the speed at which local governments are piling on debt to pay for public works.

China’s state auditor said in its report on Monday that local governments had total outstanding debt of 17.9 trillion yuan ($2.96 trillion), including contingent liabilities and debt guarantees, at the end of June.

Although the debt load shows China’s government to be far less indebted than fiscally-troubled Japan and Greece, it raised eyebrows among analysts for its 67 percent jump since the last state audit was published in 2011.

The auditor did not say which provinces have the heaviest burdens or face the biggest risks, except to note “certain” dangers in some unnamed regions.

“Any improvement to fiscal transparency will be limited unless the central government regularly publishes similar audit reports,” Standard & Poor’s said separately in a note on Tuesday. “It’s also unclear whether China will disclose the debts of individual local and regional governments.”

Investors have long viewed China’s mountain of local government debt as one of the biggest threats to its economy.

Market fears that China’s banking system will be compromised if a portion of the government debt is not repaid were amplified by a dearth of information in the past year.


Amid growing public skepticism about China’s fiscal health, Beijing in August ordered a comprehensive review of all government balance sheets. A delay in its release – publication had been expected by October – fed speculation the debt-total could top $4 trillion.

In China’s defense, the audit is a massive task. The audit office said it deployed nearly 55,000 workers, who examined nearly 2.5 million loans and reviewed the books of 62,215 governments and organizations.

The need for transparency is not lost on Beijing.

In a plan published in November about China’s most ambitious road map for financial reforms in 30 years, Beijing said it would create a “standardized and transparent budget system” for local governments and the funding of public works. This was on top of frequent government pledges to “cast sunlight” on debt.

To be sure, China is mulling other options for cleaning up its debt mess, including allowing private investors to pay for public works, and letting the central government absorb more spending responsibilities.

But no plan resonates better with reform-minded officials than that for a municipal bond market, partly because it fits perfectly with China’s goal of reducing central planning to let financial markets work their magic.

Underscoring the importance placed on restructuring the economy, state news agency Xinhua said President Xi Jinping will head a group that will lead reforms which include relaxing state control over the yuan. <CNY/>


Under China’s laws, local governments are not allowed to borrow from banks even though they are responsible for as much as 80 percent of all public spending, but take only around half of fiscal income.

To get funds, local governments set up firms that borrow for them. When Beijing clamped down on this in 2011, governments changed tack and turned to shadow banks. Monday’s audit showed shadow banks accounted for at least 13 percent of all local government borrowings.

Facing savvy local officials quick to change financing strategies to evade rules, Chinese experts have championed creation of a municipal bond market. Such vehicles, they say, will decide which governments deserve funding, and spendthrift ones will be punished with higher borrowing costs.

Beijing appears to like the idea, and is testing the ground for such a bond market in six prosperous cities including Shanghai and Guangdong.

But short of full disclosure of just how much governments take in and borrow, analysts doubt China’s experiments with its local bond market will go far.

“Banks and rating agencies do not have easy access to local governments’ overall fiscal position, which includes not only budgeted revenue and expenditure but also extra-budgetary revenue and expenditure,” the International Monetary Fund said in October.

“This lack of transparency prevents banks and rating agencies from pricing credit risk properly and prevents local governments from managing related risks prudently,” it said.

China local government debt hits $3 trillion

By Charles Riley and Sophia Yan  @CNNMoney December 30, 2013: 6:21 AM ET

China’s local debt levels have risen dramatically in recent years.


China revealed the results of its national audit Monday, giving the world a rare look at its rapidly expanding local debt levels.

China’s National Audit Office said that local government obligations hit 17.9 trillion yuan ($3 trillion) by the end of June — a dramatic increase from the 10.7 trillion yuan figure reported in 2010.

The audit office said that debt levels are still controllable, echoing the statements of top Communist Party officials in recent months.

For now, China’s local government debt remains lower than that of many other advanced economies, such as the U.S., U.K., France, Japan, Germany and Spain.

But what is scary is the pace at which debt has accumulated. China’s increase in local government debt is part of a larger issue — a credit explosion as regional governments borrowed to finance major infrastructure projects to combat a slowing economy.

Mushrooming credit is cause for concern as it has often been followed by financial crises in other emerging markets. In China, it has stoked fears that capital has been misallocated, and has further contributed to a run-up in corporate and government debt.

While the Chinese government has repeatedly said debt levels are manageable, resolving the problem has become a major policy goal.

Overall growth is slowing in China. The country is estimated to post 7.6% GDP for 2013, just above the government’s official target of 7.5%, state media reported last week. That compares with 7.8% last year, 9.3% in 2011 and 10.4% in 2010.

Reducing reliance on credit will remain one of China’s greatest challenges as it seeks to find a sustainable growth path. The government was recently tested on this issue, with the central bank forced to pump nearly $50 billion into the financial system to prevent a second damaging cash crunch this year.

Some analysts criticized the central bank for waiting too long, arguing that an earlier move could have been more effective in countering the seasonal shortage of cash. Others said the central bank’s apparent reluctance to inject emergency cash is the start of a more prudent policy approach as it’s one way of reining in excessive lending.

China’s Murky View of Local Debt

A Crisis May Not Be Imminent, But More Clarity is Needed


Dec. 30, 2013 8:32 a.m. ET

China’s local government debt problems are growing. The trouble is keeping an eye on what’s what.

Beijing’s long-awaited government debt audit arrived Monday and showed local liabilities came to around 17.9 trillion yuan ($2.95 trillion) at the end of June, up from 10.7 trillion at the end of 2010. Combined with central government debt and indirect liabilities such as those of the former railway ministry, China’s total government debt came to 30.3 trillion yuan, or around 53% of GDP, a modest level by global standards.

But these figures may not capture the full range of contingent liabilities. And it isn’t clear from the government release whether this latest report is comparable to the 2010 audit in terms of what’s counted.

What is clear is that local government debts have risen imprudently fast and reflect deep structural issues that will make it difficult for the economy to grow as quickly as Beijing wants. Banks and other lenders are stuffed with short duration loans to beleaguered local governments that fund questionable infrastructure or projects that have a payback only after decades. Moody’s survey found that only around half of local government financing vehicles had the cash needed to meet debt payments this year. Yet defaults are rare, as lenders rollover loans.

Of course, China’s ample domestic savings means a serious debt crisis isn’t imminent. And reforms outlined at the recent Communist Party congress to boost local governments’ tax revenue and budgeting transparency will improve the situation over the long term.

Meanwhile, however, the most likely scenario is for lenders to continue forbearing. More than 20% of the local government debt counted in the audit came due this year. Another 40% is due in the next two years. Rolling debt has costs: It weighs bank balance sheets with unproductive lending and creates moral hazard as debtors are spared the consequences of poor decisions. Ultimately, either the central government steps in with a bailout, or banks and shadow lenders will have to write down the bad debts.

For such an important aspect of the economy, investors should get more than a sporadic audit of local government debts every couple of years. Until then, it will be hard to measure whether China is fixing the situation or kicking the can down the road.

China Local-Government Debt Surges to $3 Trillion

Risks From Debt Are Still Controllable, Audit Office Says


Dec. 30, 2013 4:25 a.m. ET

BEIJING—China’s local government liabilities jumped to nearly $3 trillion at the end of June, according to a new audit, offering a much-anticipated glimpse into the financial health of the world’s No. 2 economy.

The sharp increase, a rise of 67% from the last tally of local government debt nearly three years ago, underscores the challenge facing China’s top leaders as they prepare to carry out a set of reforms to keep the economy humming. Also on Monday, the Chinese Communist Party said top leader Xi Jinping would head a new group overseeing the implementation of reforms.

The audit released on Monday showed China’s local government liabilities totaled 17.9 trillion yuan ($2.95 trillion) at midyear, according to a report released by the National Audit Office. China’s last full audit of local-government borrowings put the total at 10.7 trillion yuan at the end of 2010.

The figure is lower than the worst-case scenario. The Chinese Academy of Social Sciences, an influential government think tank, estimated last week that spendthrift local governments were on the hook for 19.9 trillion yuan of debt.

It also puts the country’s overall debt within the internationally recognized “red line” of 60% of gross domestic product. As of the end of 2012, China’s total government liabilities came to 53.3% of GDP, according to Wall Street Journal calculations using the figures in the report.

Still, figures show a surge in local borrowing that economists worry could hobble the country’s financial system and prompt a costly bailout. Slowing economic growth and increasing debt could lead to a rise in bad loans that could hit China’s big state-controlled banks, a major source of funding for growth.

It also shows weaknesses in the way China spends its money. China generally gives its central government the power to collect taxes, while local governments fund themselves in other ways, like selling land to property developers. Local governments are also generally prohibited from borrowing directly from banks. But many have set up special investment companies that allow them to skirt those rules.

China’s central government is less indebted than the cities and provinces, with 12.4 trillion of liabilities. Combined, the liabilities of central and local governments stood at 30.3 trillion yuan as of the end of June, according to the report. The tally includes direct debt as well as guarantees and other potential liabilities.

The audit office said in the report that risks from local government debt are still controllable. That echoes recent comments by top Chinese leaders, including Premier Li Keqiang, who has said local debt remains within safe levels.

The worry isn’t the amount of debt but its rapid growth, as well as maturity mismatches, said Ting Lu, an economist at Bank of America Merrill Lynch.

But the central government, with its low debt and $3.5 trillion in foreign exchange reserves, is well-placed to take the burden off overstretched local governments, Mr. Lu said. “We don’t believe China is on the brink of a debt crisis, especially if the new leaders can take decisive measures to arrest its rising leverage,” he said.

Earlier this month, at a conference on economic policy, China’s leaders tried to dampen speculation that the central government would step in to bail out localities that run into trouble.

“Every level of government will be responsible for their own debt,” said a statement released after the meeting. The leadership also pledged to “strictly control the process by which governments raise debt.”

In response to the 2008 financial crisis, many local governments undertook major spending projects to keep economic growth on track. The National Audit Office, in an effort to get a more accurate picture of borrowings at the local level, said in July it had started a comprehensive investigation into local-government debt. The agency said in its report that local government debts had “increased rapidly,” and that local governments are very reliant on land sales to repay their borrowing.

The audit also covers the debts of various other arms of the state, including the state-owned railway company and Central Huijin Investment Co., Ltd., the investment arm of China’s giant sovereign-wealth fund.

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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