By Minxin Pei
China appeared to weather the global economic downturn better than most. But massive local government debt could bring growth to a screeching halt.
China’s remarkable economic rebound after the global economic crisis in 2008-2009 has been a source of envy and puzzlement for the rest of the world. Instead of recession, the Chinese economy has recorded double-digit growth, and is actually showing signs of overheating – a sharp contrast with the stagnation in most Western countries. How did the Chinese do it? Perhaps advocates of ‘Chinese exceptionalism’ are right after all: Beijing has found a secret formula of economic success that has eluded the West.
Part of the answer to this mystery was given in late June by the Chinese government. It turns out that Beijing has managed to keep its economy growing during the global slump by resorting to massive bank lending to local governments, which then went on an infrastructure spending binge that’s certain to haunt the country for years to come. If we remember the causes of the economic crisis that has ravaged the United States and Western Europe, the most important one is something euphemistically termed ‘credit boom’ – excessive lending and borrowing that fuelled housing bubbles and unsustainable consumption. China seems to have been afflicted with the same disease, with only one major variation: much of the debt incurred in China has gone into the infrastructure sector, not consumption. So much for Chinese exceptionalism.
Based on the figure released by the National Audit Office (NAO) at the end of June, local governments have accumulated debts totalling 10.7 trillion renminbi (RMB) or $1.65 trillion – about 27 percent of China’s GDP in 2010. Because the NAO’s figure was based on a sampling of 6,500 local government-backed financial vehicles (out of more than 10,000 such vehicles nationwide), the actual magnitude of local government indebtedness is much greater. The People’s Bank of China, the central bank, recently estimated that local government debt totalled 14 trillion RMB (most of which was owed to banks), almost 30 percent higher than the NAO figure.
Several interesting questions are raised by the revelation of local government debt in China. First and foremost, it has shown that public finance in China is in much worse shape than previously thought. On paper, China’s debt to GDP ratio is under 20 percent, making Beijing a paragon of fiscal virtue compared with profligate Western governments. However, if we factor in various government obligations that are typically counted as public debt, the picture doesn’t look pretty for China. Once local government debts, costs of re-capitalizing state-owned banks, bonds issued by state-owned banks, and railway bonds are included, China’s total debt amounts to 70 to 80 percent of GDP, roughly the level of public debt in the United States and the United Kingdom. Since most of China’s debt has been borrowed in the last decade, China is on an unsustainable trajectory at the current rate of debt accumulation, particularly when economic growth slows down, as it’s expected to do in the coming decade.
Photo Credit: David Dennis
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Frankie Fook-lun Leung
China’s economy and her financial system is not fully integrated with the rest of the world. Hence she can shelter the adverse effects of a melt-down or crisis in a way different from Italy or Ireland. However, one would not expect China to withstand those pressures by standing along and away from the rest of the world. Chinese leaders are worried since their domestic situations of unemployment, social unrests, disparity of wealth, corruption and inefficiency will sooner or later surface, however hard the government try to hide or suppress them.
CorkerG
After reading many of these posts, I understand that my knowledge of government spending and borrowing and how it affects economies is very limited, so please forgive any unusual thoughts I may have concerning this matter.
Private businesses show all assets (revenue, property, land, equipment, vehicles, etc.) to prove solvency, and if I’m not mistaken, governments only show revenue and expenses.
If this is the case, can governments set up their financial program like private companies? Because if they do, then most every large country, especially the United States, Europe, Japan and China must be able to show assets that range into the hundreds of trillions of dollars.
And since many of these governments have assets in this range, then our governments must be completely solvent, especially since the largest debt, that I know of, is only a mere 14/15 trillion dollars (US).
Like I said, I am not aware why governments set up their financials without using all their assets, but would it make more sence for all to show their true solvency?
Muhammad
So you suggest when govt’s don’t have money to repay debt, start giving out land to say other countries to whom the debt is owed to ?
Solvency in this case is availability of cash – or cash equivalent. Of course govt’s should count their cashable assets like Gold reserves in the picture if that is the point.