Local Government Debt: Too Big to Fail?

In China, the concern about the debt of local governments is growing. Just over 40 percent of their bonds fall due this year. For many, it is unclear whether they can be repaid. The loans were mainly for infrastructure projects. Local authorities borrowed heavily through corporate bodies they created, to meet borrowing standards set by banks, to finance infrastructure and other projects. Local government debt is regarded as one of the biggest risks for the Chinese economy and the banking sector. it hit 10.7 trillion yuan ($1.7 trillion) at the end of 2010, or about 27 percent of China’s gross domestic product, according to a report from the National Audit Office (NAO) on June 27.

Just recently, the rating agency Moody’s warned that the risk of outstanding debt, saying its potential failure rate would be significantly underestimated and there’s a great danger for the country’s economy.

The Chinese government denies this: the risk was under control and should not be overestimated. A representative of the Ministry of Finance said that the regions have enough resources to pay their debts: “In addition to tax revenues, they have real estate or shares in state enterprises and other assets. The assets exceed the liabilities by far.”

To reduce the risks in the banking sector, China also plans to introduce new minimum capital requirements for banks. Accordingly, non-systemically important banks are to achieve a core capital ratio of 10.5 percent, and 11.5 percent for systemically important banks. Currently, Chinese banks achieved an average ratio of 12.2 percent.