Exaggerating China's local government debt
- By John Ross
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China.org.cn, July 25, 2011
However, by this time sensationalist coverage was appearing. The New York Times carried an analysis by Lina Song claiming "local government debt in China is a time bomb." US analysts Michael Pettis, who previously inaccurately claimed the US would be one of the first countries out of the financial crisis and China would be one of the last, wrote a piece claiming "dangerously high levels of municipal debt". The International Herald Tribune carried an analysis under the self-explanatory headline: "Threat lurking under China's explosive growth; Mountains of debt used to create infrastructure bring risk of bad loans". As the whole issue is typical of the methods by which the reality of China's economy is distorted it is worth analysing.
First, Moody's has either to satisfactorily reply to the fundamental point made by China's Central Bank or it should withdraw the report – it hasn't done either to date. However, for the sake of argument, take a worst case scenario and assume the Moody's report was accurate. It would still not mean that there was any fundamental threat to the stability of China's financial system.
When China launched its stimulus programme in 2008, to deal with the consequences of the international financial crisis, this necessarily involved sharply increased bank lending. This helped generate economic growth. This was far preferable to the situation in the US, UK and other countries where reduction in bank lending worsened the recession.
The Chinese authorities were not naive however, and knew that if bank lending is increased in conditions of financial crisis there is bound to be an increase in bad loans. Banks were therefore ordered to increase provision for bad debt and raise extra capital. The calculation was the simple and rational one that the gain from economic growth would allow the increased level of bad debt to be written off without significant problems and this was preferable to economic downturn.
The accuracy of this calculation was shown by the fact that since 2008 China's economy has expanded by over 30 percent, or $2 trillion, while the US economy has only just regained its pre-crisis GDP level.
As was therefore entirely predictable, bad debts have appeared, some in local government. As was equally predictable the rapid economic growth in the intervening period gives China's government more than enough resources to deal with them.
This entire process was gone through before in the last decade, when China's debt was higher than it is now. In 2001 bad loans from China's state banks accounted for 41 percent of GDP – partially because of the stimulus programme launched to successfully overcome the effects of the South East Asian debt crisis. As Yang Yao, director of the China Center for Economic Research, Peking University noted on this: "The Chinese economy was able to grow so fast that the government could write off the non-performing loans without much pain." And a decade later China's banks now have the highest market capitalisation and profitability of any in the world.
The same exists today. Rapid economic growth generated by the stimulus package gives China's government easily enough revenue to recapitalise banks even if the worst scenario of Moody's were to be true – which we repeat it has not presented any satisfactory proof of.
In short the whole alleged "local government debt crisis" is wildly exaggerated. There are enough serious problems in the world economy today to deal with not to waste time inventing them. The US government is not going to default. China's banking system is not going to default. In the short or medium term Greece is going to default. Anyone wanting to deal with the real world should concentrate on its real problems.
The author is a columnist with China.org.cn. For more information please visit: http://www.china.org.cn/opinion/node_7080931.htm
Opinion articles reflect the views of their authors, not necessarily those of China.org.cn.
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