China's US$3 trillion Local Government debt problem proves sticky, says S&P

HONG KONG -- China's efforts to exit RMB20 trillion (US$3 trillion) in hidden local government debt has been ineffective, according to S&P Global Ratings. "China's central authorities have tried to force local governments to drag their liabilities into view, and onto balance sheets," S&P Global Ratings credit analyst, Susan Chu, said.

 "They also want local governments to solve their debt problems with their own resources."

However, she said, local governments also needed to contend with rising deficits and indebtedness that came amid pressure to invest -- to boost the Chinese economy.

"These objectives are often at odds with each other. Local governments would be stretched to borrow more while recognising billions of dollars in fresh liabilities--investors might flee," she said.

"We define hidden debt as off-balance-sheet borrowings that local governments implicitly back.

"Much of this debt was borrowed at the level of local government financing vehicles (and) governments have used this capital largely to ensure their region meets GDP targets set by central authorities.

"We found that, while the quantity of China's hidden debt problem is steady, the quality of the total debt composition is changing.

"Specifically, local governments are putting new debt on their balance sheet, at the direction of central authorities.

"This new debt is focussed on projects backed by cash flows, and will make up an ever-increasing portion of local governments' total debt.

"We expect local governments' on-budget borrowings to rise more than 10% over the next two years, supported by central authorities' willingness to let local governments fund capital expenditure with bond issuance.

"Local governments' off-budget debt will likely rise at the mid-single-digit level only over this period."

Chu said: "We also found that the top tier of local government -- the richest and best-connected local governments -- are better placed to exit hidden debt.

"This top tier has sufficient buffers to manage the most severe market or economic disruption. This can be mainly attributed to their better discretion, especially in capital expenditure.

"The lower tiers of government, however, will have much greater difficulty exiting hidden debt, we project."

The report said this meant that the proportion of China's off-budget debt would increasingly be held by the lower tiers of local government, which had fewer resources to manage the liabilities.

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