Column: China’s Domesday debt survey
By James Saft
(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 People’s Daily.
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 any.
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.
This won’t be quite doomsday, but as one more piece of evidence that China is aiming for higher quality, if slower, growth, the local debt audit is a big story.
(James Saft is a Reuters columnist. The opinions expressed are his own)
(At the time of publication, Reuters columnist James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click on)