China orders audit of regional debt
The State Council told the country's audit office to suspend work on other projects and launch an immediate inquiry to assess the gravity of the risk. The audit office in the northern port city of Dalian has cancelled holiday leave and will dispatch inspectors this week.
Andy Xie, a commentator at news site Caixin, said reliance on land sales to fund regional spending was an accident waiting to happen.
"While household income may have tripled in a decade, the average land price has risen by over 30 times," he said. "Income growth to come cannot justify the current price of land. Nor can a supply shortage. China has no shortage of land. The sustainable land value is probably 70 to 80 per cent below current levels."
He said there may be financial panic in months ahead but the government should ride out the storm.
"The impact on the real economy will be limited," he said. "China's land bubble has become almost entirely a financial phenomenon. Its problems should be contained within a small if vocal community."
The IMF is less sanguine. It warned last week that local government reliance on "off-budget activity" and land sales to pay its bills have pushed China's underlying fiscal deficit to 10 per cent of gross domestic product.
"Fiscal space is considerably more limited than headline data suggest," it said.
The IMF said these deficits "raise questions about local governments' ability to continue financing the current level of spending and service their debts, which has implications for financial system asset quality".
"Further rapid growth of debts would raise the risk of a disorderly adjustment in local government spending," the IMF said. "Financial distress would lead to a contraction in credit, a fall in domestic demand and lower growth, which would make it more difficult for highly leveraged borrowers to grow out of their debt."
An audit of the regions two years ago found that liabilities had mushroomed to $US1.7 trillion but the full figure is already higher and rising fast as officials turn to the shadow banking system.
Ma Xiaofang, a senior audit officer, said the chief concern was the reliance on land sales to pay off half of all past debts.
The new audit comes weeks after a "stress test" of Chinese banks caused interbank lending to seize up.
SHIBOR [the Shanghai Interbank Offered Rate] has fallen back from extreme levels in June but borrowing costs remain high and there are signs of capital flight.
Fitch Ratings said investors withdrew an "unprecedented" $US42 billion from Chinese money market funds last month, many fearing the funds would run dry.
Richard Koo, of Nomura, said that Beijing pushed regions into taking on more debt to keep growth going after the Lehman Brothers crash.
A third of local government debt cannot be repaid, yet officials are split over the wisdom of a central government bailout.
Frequently Asked Questions about this Article…
China’s State Council has ordered an urgent audit of local government debt. The country’s audit office was told to suspend other projects, cancel leave (the Dalian office has already cancelled holiday leave) and dispatch inspectors immediately to assess how serious regional borrowing risks are.
The audit was prompted by warnings from the IMF about rampant regional borrowing and concerns over ‘off‑budget’ activity, land‑sale dependence and shadow banking. Recent bank stress tests and signs of capital flight and high borrowing costs have also increased pressure for an immediate check on local finances.
A previous audit two years ago found regional liabilities at about US$1.7 trillion, but the article says the full figure is already higher and rising fast as officials turn to the shadow banking system. The IMF also estimates China’s underlying fiscal deficit at around 10% of GDP, signalling growing fiscal strain.
The IMF warns that rapid debt growth could lead to a disorderly adjustment: financial distress, a contraction in credit, weaker domestic demand and lower economic growth, all of which can hurt asset quality in the financial system. For retail investors, that can mean higher volatility in Chinese markets, pressure on bank stocks and potential impacts on funds with China exposure.
A recent stress test of Chinese banks caused interbank lending to seize up. SHIBOR (the Shanghai Interbank Offered Rate) eased from extreme June levels but borrowing costs remain elevated and there are signs of capital flight, indicating ongoing stress in interbank liquidity.
Yes. Fitch Ratings reported that investors pulled an ‘unprecedented’ US$42 billion from Chinese money market funds in the past month, with many fearing those funds might run dry—an indicator of sharply reduced investor confidence.
Local governments have relied heavily on land‑sale revenues to fund spending and to pay off past debts—reportedly covering as much as half of past liabilities. Commentators (eg. Andy Xie) argue land prices have risen far faster than incomes and that sustainable land values may be substantially lower, making this funding model fragile.
The article says officials are split on the wisdom of a central government bailout. While some observers note Beijing encouraged regions to borrow after the Lehman shock, analysts also warn that a bailout is not assured and that a significant portion of local debt may be hard to repay, so investors should not assume an automatic central government rescue.
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