Hidden Debts Accumulate at Local Levels

Hidden debt is piling up at municipal and county governments, a growing risk that cannot be overlooked, senior members of the National People’s Congress (NPC) warned recently.

As of the end of 2016, Chinese government debt totaled 27.33 trillion yuan ($4.17 trillion), or 36.7% of gross domestic product, according to data from the Ministry of Finance. Regional and local governments had 15.32 trillion yuan of debt combined, or 80% of their total income including fiscal revenues, earnings from land sales and payment transfers from the central government, the data show.

The indebtedness of the Chinese government in percentage terms is still lower than that in other major developed and emerging economies. The debt burden of local governments is also below international warning levels of 100%-120%. But some cautioned that systemic risks due to hidden debt haven’t been properly accounted for.

“If you look at the data, the current debt level is manageable,” said Yao Sheng, former vice-chairman of the Budgetary Affairs Commission of the NPC Standing Committee. “But the issue cannot be overlooked since large amount of hidden debts are still unaccounted for.”

Financing through trusts and other forms of shadow banking activities ballooned to 40 trillion yuan in China as of end-2016, as financing outside the formal banking system enables lenders to skirt the regulator’s risk-management protocols and chase after high-yield products.

Municipal and county governments have been funding their infrastructure or property projects with loans offered by trusts through an opaque web of transactions, as bank lending alone was not enough to meet their funding needs. These loans are ‘hidden’ as they are part of the shadow banking system, and sometimes it is difficult to pin down who the actual borrowers are, making it difficult to assess risk.

Li Shenglin, chairman of the Financial and Economic Affairs Committee of the NPC, said hidden debt is concentrated at the municipal and county government levels. And in some cases, hidden debt at local governments could be as big as their entire balance sheet.

Those hidden debts have been poured into less liquid assets and the repayment ability of local governments relies on the appreciation of land and properties, Li said. Some local government financing vehicles tend to roll over the hidden debt or even borrow new loans to cover the interest of previous loans, Li added.

Gu Shengzu, vice-chairman of the NPC Financial and Economic Affairs Committee, added that hidden debt could become China’s biggest “gray rhino," or high-impact threat that has been neglected.

Key to contain risks

Wu Xiaoling, deputy head of the Economic and Financial Committee of the NPC, said regional and local governments took on debt to pursue GDP targets or fund “excessive” public works.

“In order to fix the debt problem of regional and local governments, on one hand we need to improve the term system and the performance assessment system of officials, on the other hand we need to have honest and reality-based planning”, she noted.

Over the past few years, the Ministry of Finance had made multiple attempts to clean up local government debts, but has achieved little.

Lü Wei, a member of the NPC Economic and Financial Committee, stressed that local officials should be held accountable for improper lending.

Gu echoed this view. In some cases, local and regional officials take on debt to boost their political performance, and leave the repayment to their successors who count on the central government to bail them out.

“We need to prevent this moral hazard, and send out a signal that there will be no financial assistance from the central government,” Gu said.

In a report to the NPC standing committee last week, the Ministry of Finance suggested that raising the debt ceiling for local and regional governments will help regulate their borrowing activities.

However, Yao disagreed with that, suggesting that given the under-the-table borrowing of local and regional governments has not stopped, it is not appropriate to raise their debt limit. He suggested the regulators to step up overseeing financial institutions and government departments to stop them from sealing deals under the table.

Contact reporters Leng Cheng (chengleng@caixin.com) and Zhang Qizhi (Qizhizhang@caixin.com)