It’s now official: last week China’s political leaders recognised the scale of China’s internal debt and its consequences. The latest releases from the Central Economic Conference were overlooked by our mainstream media as Holden’ demise and Mitch’s bowling offered more gripping reading, but few issues are of such importance than China’s admission that its debt driven growth model has got out of hand. In brief several post conference communiqués said:
1) China’s local government debt levels had to be addressed
2) GDP was no longer the best measure of performance for promotion
3) Local governments will be held accountable for the debts they incur and,
4) Over-capacity across China must be wound back.
While some of this had been covered in veiled form before, the change criteria for career advancement was a radical break from the past. Equally sharp edged was so was the line drawn in the sand on the responsibility for debt.
What was not said was perhaps even more important. No figures were released from the recent National Audit perhaps because they were too unpalatable to publish, but with the IMF and all major ratings in broad agreement about the scale debt run-up, particularly at the local government level, it was impossible for leaders to ignore the US $3.3 trillion in debt added since 2008-09.
That was when the starter’s gun went off for a huge stimulus program of $4 trillion Yuan to create employment as export orders slumped. The Provinces then got into the act on a grand scale. First Financial Daily, a Shanghai publication, estimates that since 2008 China’s debt is up five-fold to US $14-15 trillion as provinces step up major infrastructure projects like highways, airports and underground rail systems. Many have heard of the vast rows of empty apartments, but of equal concern are the empty office precincts and business parks built on spec. Officials say they are not worried as the debts can be met by land sales and local revenues but Fitch estimates that debt service of interest and principal is now equivalent to 38-39% of China’s GDP. As debt is borrowed to pay interest, the ratings agency expects total debt to reach 250% of GDP by 2017.
These debt ratios are now lifting yields of corporate bonds with Bank of America is warning of undue complacency and redemption shock in 2014 as growing debt falls due.
Why these figures remain out of sight in our mainstream media is a puzzle. The view until now seems to have been that either China is fiscally very well managed, or that China’s savings are so large this self-admitted over-capacity can continue to grow, or alternatively, those closer to the reality may simply think that since this debt is largely internal Beijing will simply bail out the banks as they have done twice since the opening of the economy over 30 years ago. It would just be shifting funds from one pocket to another. That would be comforting for us and our economy, but the softly spoken message from the Economic Conference said precisely the opposite. It was now up to the Provinces to pay their own debts.
The problem is that the funds are no longer communal. China is partly privatised. Social ownership and private ownership now co-mingle in a complex pattern of linkages that will entangle not just private depositors, but thousands of developers who borrowed through local government financing vehicles who in turns raised funds from land sales and “investment products” which often promised rates of 10-12% on projects that often have no cash-flow or, due to endemic over-capacity, have simply collapsed.
Whether Beijing as a matter of politics can wash its hands of provincial debt is another matter. The provinces with their city and local district administrations have no taxing powers and no capacity to raise loans other than by the back door of the “shadow banks.” Their income is also limited as they only receive 25% of the national VAT tax and use land sales and fees and charges to try to make up the balance.
Many are not in balance. If a relatively sophisticated first tier city like Guangzhou has debt to GDP levels of 98-100% the situation for many lesser provinces is far worse as they borrow to pay outstanding interest on industrial parks, underground rail systems, freeways and sports stadia in an attempt to create amalgams of Los Angeles, New York and Hong Kong from a standing start.
Adding to the risks is the current melt up in property prices in the first tier cities as the big developers snap up large parcels at almost any price. In prime areas prices per metre have jumped 80% over last year on the assumption that scale will always win over cash-flow considerations.
This combination of policy change and debt-servicing risks as has no doubt triggered concerns of people like the newly installed Governor of the Bank of England, Mark Carney. Over the weekend he said the financial crisis in the advanced countries was over, but the risks were now rotating from west to east. In an obvious reference to China he said, “The greatest risk face the international economy was the parallel banking sector in the big developing countries”.