China's local government debt

Credit quality polarised among China’s local governments

Not all of China's local governments are drowning under the weight of their debts, according to a report by Standard & Poor's.
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Qingdao, in Shandong province, where the local economy is thriving
<div style="text-align: left;"> Qingdao, in Shandong province, where the local economy is thriving </div>

It is often assumed that China’s local and regional governments are all mired in unsustainable debt, but it turns out that not all provincial governments are created equal.

Rating agency Standard & Poor’s has spent the past few years assessing the creditworthiness of several local governments in China and found wide variation. Some of them do indeed have big debts and contingent liabilities, but many others boast solid budgetary performance and ample liquidity, S&P said in its report, published yesterday.

The credit ratings it has assigned range from speculative grades of B to BB, up to the investment-grade level of AA-, which is the same as China’s long-term sovereign credit rating.

Even without the central government’s financial support, the well-off coastal cities and special economic zones find it relatively easy to finance their debts compared to their less wealthy inland peers. This is mainly because China’s coastal provinces tend to be wealthier, have more diversified economies and better access to other sources of revenue, such as land premiums — and that means their credit quality is relatively stronger, even though their indebtedness is high.

Shandong, a coastal province in north-east China, has the lowest debt-to-revenue ratio among the areas S&P covered, with slightly more than 100%, followed by Guangdong, known as China’s wealthiest province, and the capital city Beijing. However, travel inland to Jiangxi and Jilin provinces and the figure climbs to more than 300%.

Beijing may encourage the issuance of municipal bonds this year after having already allowed four local authorities to directly issue bonds in the last quarter of 2011. However, it may restrict access to the bond markets to governments with high credit quality, particularly during the early stages.

China’s local and regional governments accumulated mountains of debt after funding an infrastructure spree commanded by Beijing to sustain the country’s investment-driven growth. This debt is regarded as the biggest threat to the country’s economy, alongside its overheated property market. According to the latest data available from the National Audit Office, the debt owed by local governments stood at Rmb10.7 trillion ($1.6 trillion) at the end of 2010, of which 79% were bank loans. Slightly more than half of the debts will be due by the end of 2013. 

But the level of indebtedness is not evenly spread. Some provincial governments in eastern China have modest debts, even compared with rated local governments in developed economies, S&P said in the report.

The difference is that China has levels of economic growth that can sustain big debt burdens — all of China’s provinces recorded double-digit GDP growth on average during the period 2006 to 2010, according to the China Statistical Yearbook — whereas the West is suffering from the twin problems of high debts and low growth.

S&P noted that its assessment was affected by poor levels of transparency and the lack of clear and economically justifiable relations between China’s local governments and some of their related financing entities.

“Credit quality among local and regional governments and the development of the municipal bond market in China could strengthen if [local and regional governments] improve the transparency of their operations and finances, accounting standards and management of government-related enterprises,” said S&P’s analyst Kim Eng Tan. “But credit quality and the market’s development are likely to be undermined if contingent liabilities continue to grow and materialise on a large scale.”

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