Last Friday, the Chinese central government ordered an immediate auditing of the countrys murky local government debt situation, stoking fears that local government debt levels are getting out of control and that the government is preparing a fresh round of crackdowns on borrowing by localities. However, our China strategists believe that prevailing fears on the local debt front are misplaced.
Beijings focus is to prevent a further rapid increase in local government debt rather than to induce a sharp contraction that could put the economy and the banking sector at risk.
The debt issues of local governments and financing vehicles have been thoroughly discussed by investors, analysts, rating agencies and market regulators both inside and outside China. A wide range of numbers have been suggested, ranging from the previous governments audit of about RMB 11 trillion to as high as RMB 25 trillion, or close to 50% of Chinese GDP. It is unlikely that the official audited numbers will fall beyond these ballpark estimates.
Local government borrowings are ultimately Chinas fiscal liability. Even under the most aggressive assumptions discussed in the marketplace, Chinas total gross public sector debt, including local and central governments, is still not excessively high compared with that of most countries. Moreover, the Chinese government also owns vast amount of assets. Therefore, the net debt situation is easily manageable, especially considering the countrys very high domestic savings rate.
Finally, the fact that the Chinese government has not come up with concrete and credible information on the level of public sector debt has been far more damaging, as it has left the door wide open for guesstimates and rumors, which in turn has weighed heavily on investor confidence. Therefore, revealing the real situation is an essential first step in addressing one of the major macro question marks on Chinas economic future.