When visitors to Chinese cities are trying to take the pulse of the local economy, they often do a very simple thing – they look out the window and count the cranes.
Crane counting is a trick used by analysts from London to Sydney to get a real-time sense of economic activity: Cranes mean construction, construction means jobs, jobs mean people have money to spend, and so on. In China, however, crane counting can be hard – sometimes there are so many you lose count. That was especially true in the years following the financial crisis, when China launched a massive investment programme, estimated at the time at around $560 billion, to stimulate the economy.
Much of the money went into infrastructure. The result? Even more cranes. Less visible, however, were the sources of some of the money to pay for all that building. That was particularly so when it came to financing from local governments, which often resorted to highly convoluted methods to raise funds. The result today is a legacy of local-government debt that, in some places, is as muddy as a building site.
Why is local government borrowing in China so opaque? There are many reasons. One is that, unlike their counterparts in many other countries, local governments in China can’t raise funds directly by issuing their own bonds. Instead, most have borrowed through specially created arms, usually known as local government financing (or investment) vehicles (LGFVs). These entities are owned or controlled by local governments but operate at arm’s length. As a result, much of local government borrowing has been kept off the balance sheet.
Another reason is that, as well as borrowing from banks and issuing bonds, many of these financing vehicles raised funds through shadow banking. That’s a term used to describe the whole host of financial institutions that provide loans but, unlike traditional banks, don’t rely on deposits to finance their activities. Crucially, and this explains the “shadow” bit, they’re not regulated like normal banks.
Shadow banks are found all over the world, not just in China. Despite their sinister-sounding name, they are not “fearsome, toxic creations,” say Andrew Sheng and Ng Chow Soon of the Fung Global Institute. However, as they also point out, some shadow banks in China, as in other countries, have promoted “opaque, usurious lending and cross guarantees that bundle shadow banking credit risks with the formal banking system, with significant moral hazard issues”.
Chinese investors got a taste of what can go wrong last year, with the default of a “trust product” created on behalf of Jilin Province Trust Company, an LGFV. As the Financial Times (paywall) notes, such products “lie at the heart of China’s shadow banking sector”. They’re complicated beasts, but essentially trust products represent a security backed by a bundle of assets – such as property, loans or shares. They can be attractive for wealthy investors because they can pay a high rate of interest. But they’re also distinctly risky.
So, how big is the local government debt pile? According to the OECD’s recent Economic Survey of China, it was approaching 30% of GDP in mid-2013. However, the numbers are reported irregularly, so the figure by now is probably higher. Estimates are complicated by the opaque nature of local-government borrowing. Indeed, it isn’t arguably the scale of the borrowing that matters so much as the fact that it’s hard to say with certainty where the risks lie.
There’s no question that local government finances – and, indeed, rising debt more widely – are a concern in China. In March, for instance, the central government sent a strong signal by announcing a debt-for-bond swap programme to help ease the repayment pain of local governments, and further action seems imminent. Despite the concern, there also seems to be a feeling that the risks are – as both the OECD and the consultancy McKinsey & Co put it – “manageable”.
However, the OECD survey also urges reforms to transform local government financing, including improving budget management and introducing greater transparency, for example by allowing local governments to raise funds through bond issues. It also advises that debt should be added to the indicators used to evaluate the performance of officials in local governments “to reduce incentives to borrow unwisely”.
网站 【中文】 (The OECD’s Chinese-language site)
China meets the ‘new normal’ (OECD Insights blog)
The OECD Policy Framework on Investment