China Auditor-General warns on local govt solvency

In what certainly will not come as a surprise to daily China watchers, the country’s top auditor has issued a new warning about the solvency of local government bodies.

The head of China’s national audit office warned on Monday that the country was facing growing risks because of a sharp rise in local government debt and poor controls over borrowing by investment companies set up by municipalities, provinces and other bodies.

Liu Jiayi, the top auditor in China, said on Monday that at the end of last year local government debt had reached $1.7 trillion, or about 27 percent of the nation’s gross domestic product. He said better regulation was needed to manage the debt risks.

“The management of some local government financing platforms is irregular, and their profitability and ability to pay their debts is quite weak,” Mr. Liu said in a speech Monday.

The release of the report by the national auditor, who works under China’s cabinet, or State Council, comes as worries are growing that China’s economy is overheating. Beijing is now trying to rein in bank lending to moderate growth and tame inflation and property prices.

On Monday, Prime Minister Wen Jiabao, who was visiting Britain, told Hong Kong television that the economy would probably exceed its inflation target of 4 percent this year.

Some analysts say an economic slowdown could expose huge hidden liabilities in the banking system. Many of the problems are tied to a $586 billion stimulus package Beijing announced in late 2008 and a huge wave of state-backed lending in 2009 and 2010. Those money infusions were aimed at buffering China from the global financial crisis.

Although many economists argue that the country’s enormous stash of foreign exchange reserves helps make Beijing strong enough to cope with the local government liabilities, they also point to worrisome signs of mounting debt.

The auditor’s report on Monday was similar to a warning earlier this month by the Chinese central bank. The bank said that at the end of last year, local government liabilities were as high as 30 percent of gross domestic product, or about $2.2 trillion — far higher than previous estimates.

That survey said local governments had created 10,000 investment companies to borrow money from banks, mostly to finance ambitious infrastructure projects. (China does not allow local governments to issue bonds to finance projects.)

But the national auditor’s report varied from the central bank’s in saying its survey had counted only about 6,500 local government investment companies. Analysts cited the possibility that that auditor’s survey was not as thorough as the central bank’s.

Many analysts have grown cautious about China’s economy. Some have reduced growth estimates and downgraded their ratings of Chinese banks over concerns about a coming wave of nonperforming loans associated with local government debt.

Last week, Charlene Chu, an analyst at Fitch, the credit ratings agency, said China’s growth had recently become too reliant on loose credit and that “easy money” was helping fuel inflation and a property bubble, according to a presentation she delivered at a global banking conference in Hong Kong.

She also said there were growing risks because of a shadow banking system that had emerged beyond regulatory scrutiny in China and because of an “overextension” of loans to local governments.

“Rapid expansion of off-balance-sheet transactions is distorting bank financial statements,” she said.

I don’t think there is really anything particularly new about this information, but the fact that this warning has been issued by the Auditor-General of the National Audit office of China in front of the National People’s Congress certainly means that it is out in the open. You also have to wonder how anyone worried about financial stability could ignore evidence like this.

The national audit office said it had found many irregular activities. For instance, many local governments were using “unreal” or illegal collateral to secure the loans, the report said, and some of the money they borrowed was funneled into the stock and property markets. At other times, the auditor said, the local governments were “overestimating the value of the collateral” — which was often tied to land values.

Just another risk to consider when analysing Australia’s financial stability.

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  1. China’s Chief Auditor General must have very difficult job!

    A while back Niall Ferguson referred to this and suggested that eventually the Chinese would simply recapitalise banks so will be of interest to watch.

    Recently Michael Pettis questioned the real value of China GDP (among other things) and may be of interest:

    Charlene Chu

  2. 27% of GDP in Local authority debt and lot over the last 2 years.

    That’s an impressive effort.

    ‘Bob the Builder of Porpise Spit’ would be quite at home.

    Just as well that the CCP cracked the 11 herbs and spices recipe on how to make local government efficient and effective or they might have a few dodgy transactions to render harmonious in the near future.

    Even if you have mountain of fx kleptomania on a grand scale is bound to sting a bit.

    3d1k – thanks for those links you are posting they are very interesting

  3. One interesting fact buried in the data was that about a quarter of the local govt debt in China is dependent on land sales for repayment. Let’s hope that property market stays afloat…