China: Local Government Debt Questioned

Econintersect:  The debt burden of local governments in China may be significantly larger than previously estimated, according to the credit rating company Moody’s.  Reuters says that the official estimate of $1.65 trillion may actually be $2.19 trillion.  That would change the default exposure for Chinese banks.  Moody’s says that banks could be facing elevated non-performing loan ratios in the 8-12% range, above the basic stress test assumption of 5-8% for the base case.From The Huffington Post:

Moody’s said it derived the additional 3.5 trillion yuan of debt after comparing the estimates of China’s state auditor with that of the bank regulator’s.

The ratings agency said the Chinese state auditor likely omitted the 3.5 trillion yuan of debt from its assessment because they were not considered as real claims on local governments.

“This indicates that these loans are most likely poorly documented and may pose the greatest risk of delinquency,” said Yvonne Zhang, a Moody’s analyst.

Moody’s said it expects Beijing to “implement gradual discipline” over the stock of government debt, and that would involve the Chinese government leaving banks to manage a part of the problem loans on their own.

Beyond the questions raised by Moody’s about the questionable accounting of local government debt, Michael Pettis (GEI Analysis) has reported on the poor credit liquidity and high costs for small and medium size business in China.  Waiching Li (GEI Opinion) has reported on the large amount of shadow banking activity in China.  There appear to be a number of problems lurking in the finances of the Middle Kingdom.

Sources: Reuters, Huffington Post, GEI Analysis and GEI Opinion