Covert “financing vehicles” face hundreds of billions of debt, reports Asia Sentinel

China’s State Council has acted to bail out to local governments which have racked up at least 10.7 trillion yuan (US$1.69 trillion) in debt steered through covert “financing vehicles” to finance a wave of development spending on empty housing complexes and over-developed infrastructure.

In the 2013 budget, the State Council granted 350 billion yuan in local government loans to be issued by the Ministry of Finance to cover local government deficits for the year. It is the highest amount of debt relief since 2008.

Some observers believe the debt levels could be as much as 13 trillion yuan, amassed against prohibitions by Beijing and creating a problem as big as the so-called triangular debt problem that nearly capsized major state-owned enterprises in the 1990s. The 10.7 trillion yuan figure comes from the National Audit Office.

It is difficult to know just how big the local government debt problem is, since debt isn’t recorded officially. The local governments financed most of it through off-budget vehicles that then borrowed through banks. There are indications, however, that many local governments are having serious problems meeting debt obligations, hearkening back to the 1990s triangular debt problem on the part of the state-owned enterprises, in which SOEs purchased materials from upstream suppliers but failed to pay. Because A couldn’t collect payment from a downstream SOE, it couldn’t afford to pay its upstream suppliers. As a result, firm A owes firm B, firm B owes firm C and firm C owes firm and nobody can collect. Eventually the national government had to bail out the SOEs to the tune of hundreds of billions of yuan.

In an indication that the government recognizes the seriousness of the problem, outgoing Prime Minister Wen Jiabao specifically said in his work report that China must do everything it can to prevent a systemic shake-out.

The debt bulge started as the Chinese government poured 4 trillion yuan into development with the onset of the global financial crisis, with the local governments required to do their part to match national goals. The local governments, handicapped by the fact that Beijing was taking the lion’s share of tax revenues, had to find new sources of financing.

Thus, despite the fact that China’s national budget law stipulates that local governments must balance their budgets and are prohibited from issuing bonds without approval of the State Council, the local governments set up companies to borrow money, “in some cases without considering their ability to repay the loans,” according to a 2012 report by the Samsung Economic Research Institute, “usually supported by some form of government assurances.”

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