HEAVY SPENDING: Vehicles drive over the recently completed Jiayue Bridge in Chongqing, southwest China. The city on April 5 announced a 1-trillion yuan ($146.5 billion) investment package for the next five years (ZHOU HENGYI)

Recently proposed Ministry of Finance measures to supervise the financing platforms of local governments and to regulate and avert risks in managing local debts have met with protests from many of the local authorities.

Local governments are left largely unchecked when borrowing money from the capital market, an issue the ministry wants to address.

In order to raise money from the market, local governments tend to set up investment and financing firms, backed by land and local revenue, which in turn acquire money from banks or by issuing local debt. The money raised is then used in large-scale investment projects—local infrastructure construction, transportation, power, chemical engineering and machinery upgrades to name a few.

Against the backdrop of global financial crisis last year, the Central Government encouraged local governments to raise money through local financing channels, like the firms mentioned above. As a result, many cities, towns and even villages set up their own local financing firms. Figures from the Ministry of Finance showed the establishment of more than 3,800 above-county-level local financing institutions to date—the number would amount to more than 8,000 if financial channels below the county level were included in the total.

A research report from China International Capital Corp. (CICC) issued in early March showed the total outstanding loans in all local government financing institutions (excluding bank notes) at the end of 2009 stood at 7.2 trillion yuan ($1.05 trillion).

China Economic Weekly reported that many of the local governments have already reached the largest amount they can sustain. The debt ratio of many local governments has surpassed 150 percent, with that of some even exceeding 400 percent.

Rising risks

"Many local governments are heavily indebted. Some have borrowed money beyond their means, and the possibilities that their capital chain can break at any time are growing," said Lu Minfeng, a finance professor at the Nanjing University of Finance & Economics.

Lu recently conducted an investigation into local financing platforms. The research showed below-county-level investment and financing platforms added 5 trillion yuan ($732 billion) of new debt to local governments in 2009. Meanwhile, money or debt raised through local financing platforms totaled nearly 2.5 times local revenues, resulting in a mounting government deficit.

In their dealings with newly established financing platforms backed by the government, banks are likely to lend due to the platforms' government affiliation and guarantee, or even government intervention in some cases, even if local institutions conceal their financial status from the banks, Lu said. In some cases, platforms double mortgaged government assets to different banks. If the financing scale exceeds what the governments can sustain, or if the investment platforms choose the wrong project and fail to achieve their targeted profits, it will be difficult to pay back the bank loans, creating instability in the financial system.

Xie Wei, Deputy General Manager of Bank of Communications Schroder Fund Management Co. Ltd., said local governments can rely on four methods to pay off debts: increasing tax revenue, appreciating land resources, investment from companies, and profits from real estate development. Among the four, income from land auction is one of the most important sources of government revenue. In 2009, the aggregated income from land auctioning in 70 large and medium-sized cities totaled 1.08 trillion yuan ($158 billion), up 140 percent from 2008.

Government reliance on land sales has caused local-level administrations to hope for increases in property prices. As a result, they tend to prop up the property market by adopting various measures, which eventually distort market operation and increase house prices. The financial pressure of buying an apartment or a house puts a heavy burden on consumers, who would rather save money to pay off their mortgages than spend money on shopping excursions.

Before 2009, the hidden debt issues of local governments had already aroused debate among economists, as they had broken the balance between income and expenditure, and were running huge deficits, Xie said. But at the time, rapid economic development and soaring housing prices helped conceal the problem of excessive borrowing from the banks. After 2009, due to the borrowing trend spurred by the Central Government's huge stimulus package, local governments accumulated high levels of debt that can no longer be ignored as problems begin to surface.