China’s Domesday debt survey: James Saft
July 30 (Reuters) – Like William the Conquerer before him,
Premier Li Kequing is initiating his own Domesday survey in
China, and this time the attempt to curb local abuses of power
will have global economic consequences.
China’s State Council, chaired by Premier Li, has ordered
the National Audit Office to begin auditing what could total $2
trillion or $3 trillion of debt taken on by local governments.
The Audit Office will suspend other work and give all staff
“crash” training so that auditors can begin fanning out across
the country this week, according to a report by the state-run
The clear implication is that China is seeking to rein in
local governments, which have helped along what is clearly a
boom and may be a bubble by borrowing and spending freely on
local development. For China, this will act as another brake on
already slowing growth. For the rest of the world, it means less
demand, especially for the kinds of raw materials and energy
which go into real estate development and infrastructure.
William ordered the 1086 “Domesday Book” census of property,
so called because it was said to be as thorough and
wide-reaching as the final judgement, shortly after the Norman
conquest of England in order to nail down who owned what and who
might have usurped something belonging to the crown he now
possessed. Premier Li, who assumed office in March, has a
related but different problem. Despite laws against it, local
governments have taken on huge debts, an amount estimated by the
last audit at about $1.75 trillion at the end of 2010.
Analysts believe that has grown substantially since then,
leading to growing concern about the country’s overall debt
profile. While the IMF has estimated China’s total government
borrowing to be a bit less than 50 percent of annual GDP (as
compared to about 100 percent in the U.S.) local government debt
has grown faster, and pays a higher rate of interest, than forms
of borrowing more tightly controlled by the central government.
Of particular interest is a story in China Business News,
citing an unnamed source, which said China had decided that it
should cap its fiscal deficit at 3 percent of GDP, well below
the 5 percent or more many economists estimate it may now be. To
do that would likely require quite a savage cutting back on
local government debt, or for central government to content
itself with a smaller piece of the pie and all the diminished
opportunities for reward, control and influence that implies.
THE HAND AUDITS ITS FINGERS
Taking a step back, the most surprising thing about this
whole story is that a government, much less one in a
single-party state, needs an audit to know how much its
constituent parts have borrowed. Little wonder ratings agencies
have expressed concern about the debt practices.
But the relationship between local and central government in
China is complicated, and, in fact, local authorities have
exercised much discretion in directing development, and, despite
rules to the contrary, contracted much debt to fund it.
Because rural land in China is held, in essence,
collectively, there is a huge and profitable opportunity for
local governments in re-badging rural land as urban or
industrial, paying off its occupiers, and selling rights or
leases on for development. So-called Local Government Financing
Vehicles are set up to do an end-run around prohibitions on
local debt and allow governments to borrow the money needed to
fund both development and the infrastructure it requires.
Much of this development has arguably been of low quality in
recent years, producing extra manufacturing capacity which may
not be needed and apartments to meet speculative demand. China
clearly needs to transition to a model in which it depends less
on investment and more on consumption, and reining in
helter-skelter local development is as good a place to start as
That said, a crackdown on local borrowing will have large
repercussions. As the U.S. demonstrated in the last decade,
borrowing and spending money to dig holes in the ground and put
up buildings is a great way to give the appearance of strong
economic growth. Limit that and growth goes down with it, though
perhaps the growth you get is more stable. Estimates of the
likely run-rate of Chinese growth have been dropping sharply,
and this will only exacerbate this trend.
Like everything in China today, what happens there matters
everywhere. The big and easy-to-pick losers are the commodities
and energy used in developing infrastructure, and those
countries, such as Australia, which produce them.