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China Reports Local Governments Owe $1.6 Trillion

June 27, 2011 (Associated Press) BEIJING - China's local governments have piled up debts of $1.6 trillion, the national audit agency announced Monday, amid mounting concern Chinese banks might be hurt if borrowers cannot repay loans.

It was the first public accounting of massive borrowing by local governments to pay for construction and other spending. The announcement, following months of speculation about the scale of the debt, might help to mollify worries about possible risks facing banks that also lent heavily to help China ward off the 2008 global crisis.

Analysts say some local governments might be unable to repay loans but a banking crisis is unlikely because China's state-owned lenders are flush with cash and avoided the mortgage-related turmoil that battered Western institutions.

Beijing has flexibility because economic growth is strong and its total government debt is well below that of the United States, Japan and some European economies, said Zuo Xiaolei, chief economist for Galaxy Securities in Beijing.

"But the government must bear the risks in mind and try to prevent the local debts expanding too fast," she said.

The National Audit Office report gave no indication what portion of local government debt might not be repaid. Its total figure was in line with estimates by outside analysts but it was unclear whether that included all government debts.

The audit office said local governments owe 9 trillion yuan ($1.4 trillion) to banks and other lenders and might be responsible for an additional 1.6 trillion yuan ($200 billion) in debt. The disclosure came in a report to China's legislature that was released on the agency website.

"Due to inadequate repayment ability, some local governments can only pay their debts by taking on still more debt," the report said.

UBS economist Tao Wang, in a report this month, said local governments eventually might be unable to repay 2-3 trillion yuan ($300-$450 billion) in loans, equivalent to 4-5 percent of total lending by Chinese banks.

Many local Chinese governments created investment agencies over the past decade to invest in construction and other projects, financed by borrowing from state banks.

An American researcher, Victor Shih of Northwestern University, has estimated total local government borrowing in 2004-09 at 12 trillion ($1.6 trillion).

Bank lending was a key element of Beijing's 4 trillion yuan ($586 billion) stimulus that helped China rebound from the global economic crisis. Beijing provided only about 25 percent of the total. The rest came from local governments, state companies and bank loans.

Regulators began to tighten controls early last year amid warnings local governments were borrowing too much.

A central bank deputy governor, Su Ning, said in March 2010 that banks might face risks if local governments defaulted. But the Finance Ministry and bank regulator later issued a statement saying risks were under control.

Many loans are likely to be repaid because they were invested in projects that will produce taxes and other revenues, analysts say. But they say some were given without required collateral, some borrowing was used for regular spending instead of investment and some governments committed the same future revenues to multiple projects.

China's top state-owned banks are among the world's biggest, with several having more than $1 trillion in assets.

Beijing injected tens of billions of dollars into China's biggest banks over the past decade to clear away mountains of unpaid loans.

"It can't be excluded that the government might remove bad debts from the banks again if there were debt defaults," said Zuo. "But that would be no good for the development of the economy and the banks as well."

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