China Economic Update – 20 February 2014

Concerns have been raised by the rapid growth in local government liabilities in recent years, with questions around the stability and security of China’s sub-sovereign debt, and the risk that a potential default could trigger a broader financial crisis.

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Concerns have been raised by the rapid growth in local government liabilities in recent years, with questions around the stability and security of China’s sub-sovereign debt, and the risk that a potential default could trigger a broader financial crisis.

China’s local governments – comprising a broad range of authorities at provincial, city, county and village & town level – have a critical role in China’s economic development, as they are responsible for the majority of the country’s infrastructure development. However under current regulations, they are prohibited from either borrowing directly from financial institutions or issuing bonds (except with specific approval from Beijing). The World Bank estimate that local governments are responsible for 80% of spending from around 40% of tax revenue.

While the scale of debt may not be too troubling (at between 41% and 53% of GDP – depending on contingent debt – considerably lower than levels in many advanced economies), the pace of this growth has been a major concern, with debts increasing more rapidly between 2010 and 2012 than either GDP or government revenues – leading to a decline in the capacity of some governments to service these debts.

Concerns of a wider financial crisis appear excessive, in part as the risks associated with local government debt appear to be weighted towards the short term, and with careful regulatory and fiscal reform, including greater transparency and accountability, these risks can be reduced significantly over the next five to ten years.

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