China’s Risky Finances

BEIJING – In the coming years, China’s government will have to confront significant challenges to achieve stable, inclusive, and sustainable economic growth. But, with mounting fiscal and financial risks threatening to derail its efforts, policymakers must act quickly to design and implement prudent, forward-looking policies.

The most significant medium- and long-term threat to China’s fiscal position lies in the system of implicit guarantees that the central government has established for local-government debt. In the wake of the global financial crisis, local governments borrowed heavily from banks to support China’s massive stimulus program, amassing ¥10.7 trillion ($1.7 trillion) worth of debt by 2011.

China’s leaders hope to control potential risks stemming from local-government investment vehicles (LGIVs) by limiting bank lending. The balance of bank loans to LGIVs increased only slightly in 2012, to ¥9.3 trillion, from ¥9.1 trillion in 2011. And the China Banking Regulatory Commission has called on banks to retain last year’s LGIV loan quotas for 2013, and to ensure that the overall balance of loans to LGIVs does not exceed the 2011 year-end total.

But LGIVs obtained a massive amount of financing in 2012 by issuing bonds and trust loans. This includes ¥250 billion in local-government bonds, ¥636.8 billion in urban-investment bonds, and technical cooperation trust-fund projects totaling ¥501.6 billion, representing year-on-year increases of ¥50 billion, ¥380.6 billion, and ¥247.9 billion, respectively.