May 14, 2010 | 11:44 GMT

3 mins read

China: Growing Local Government Debt

About 40 percent of China's new loans in the first quarter went to local government investment arms, according to Wei Jianing, deputy head of the macroeconomic research department at the State Council's Development Research Center. Wei added that local governments used to have two to four of these investment arms but that the average rose to 10 in the past year. He also gave statistics for 2009, saying local government debt rose to 6 trillion yuan ($878 billion), up from 1 trillion yuan at the beginning of 2008, to emphasize the ballooning of new borrowing by local governments. Estimates vary on the size of the total local government debt, ranging from the official 18 percent of gross domestic product (GDP) to an estimated 33 percent of GDP. Even more worrying is the speed with which that debt has grown in the past two years. China's local governments are not allowed to issue debt (aside from a few experimental exceptions), and thus they create investment arms to borrow money from banks that is then used to finance local public projects. Wei's comments show first-quarter local government debt stayed at exactly the same share of new loans as it did the whole of 2009. While the central government decreased lending by about a third in early 2010 compared to the previous year, credit policy remains loose in comparison with pre-crisis years, and thus local governments continue to rack up large amounts of debt. Local government borrowing on this scale presents a major problem for the Chinese state, as local officials frequently misuse or misdirect the loans, tending to deploy the funds in ways that are politically desirable but not economically profitable. This is especially troubling given that according to Wei about 70 percent of local government investment arms are at the subprovincial (district or county) level, which suggests even less competence on the part of those responsible for using the loan money. Moreover, as the central government makes initial moves to slow down the frenetic growth in its real estate sector, it fears local governments — which draw anywhere from 20-45 percent of their tax revenues from land sales — will see their finances suffer, hurting their ability to pay back the ballooning debts. Beijing has claimed in recent months that it will address these systemic risks by restricting lending and reviewing the practices of an estimated 3,800-4,000 local government investment vehicles. But it is too early to tell how effective this supervision and regulation will be, especially given local officials' inevitable resistance.

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