Billions of dollars of debt racked up by local Chinese governments during their investment sprees are likely to sour as the projects they finance near completion, Yin Zhongqing, a prominent Chinese lawmaker, said this week.
In an interview with Reuters Insider, Yin said local governments had incurred at least 10 trillion yuan ($1.5 trillion) of "hidden" debt, which they have concealed by creating thousands of investment vehicles that serve as borrowers.
Yin said it is not yet clear which loans will sour because they do not have to be repaid until the projects are completed.
"The large amount of debt that local governments took on since the end of 2008 to battle the impact of the global financial crisis will become a heavy burden for our development going forward," said Yin, who is a member of the finance and economic affairs committee in China's parliament.
He highlighted the high risk of default in the low-level county governments, which Yin said have little financial resources.
"Seventy percent of the loans from these investment and financing platforms in 2009 and 2010 were generated at the county level, where governments don't have much assets, and some cannot even afford to pay their staff," he said.
"Debts accumulated from these platforms, even with government financial guarantees, simply cannot be paid back. In other words, when they borrowed the money, local governments did not plan to pay it back."
Local Chinese governments are barred by law from borrowing directly. To pay for their ambitious growth plans for cities, they set up investment vehicles that take out bank loans backed by assets - typically land - or implicit government guarantees. They do not show up in official central government debt accounts.
But Yin said these debts will ultimately have to be written off by Chinese banks and Beijing. "In 2009 and 2010, we encouraged them (local governments) to increase debt and run deficits to stimulate investment. Local governments' debt problems will come to light in 2011," Yin said.
He said local Chinese governments were still pursuing breakneck growth rates despite pleas from Beijing to slow down to let the economy tread a more steady and sustainable path.
"We need to use macro controls to pull it back and lower it to a reasonable level," Yin said.
While the problem of "hidden" debt among local governments is not new to China, its massive three-year stimulus program in the wake of the 2008 financial crisis exacerbated the issue.
China's bank regulator estimated last year that local governments have racked up 7.66 trillion yuan in debt as of June 2010, of which 26 percent is unlikely to be repaid.
But the regulator put a brave face on the problem by saying the risks are under control since most loans can eventually be repaid using income earned from their investment. It also said banks are well protected against defaults because they have already set aside adequate provisions.
Yin warned against complacency, however, and said China's debt ratio was much higher than what official data suggests.
Beijing has said its fiscal deficit will fall below 2.2 percent of gross domestic product (GDP) in 2010, while its total debt will be less than 20 percent of GDP.
"China's rapid development has covered up many problems. But once economic growth slows down, these problems will emerge as stones rise when water levels fall," Yin said.
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