If you ask China watchers to list threats to the country's economy, you would probably get this one item on everyone's list—hefty local government debt.
China released the results of a long-awaited nationwide audit on government debts in an attempt to ease mounting market concerns over the amount of debt and its possible impact.
Local governments' direct debts—debt that will be repaid by the government's fiscal revenue—reached 10.9 trillion yuan ($1.79 trillion) by the end of June 2013, with the government holding another 7 trillion yuan ($1.16 trillion) in contingent debts, according to the National Audit Office (NAO) on December 30, 2013. The contingent debt includes debt for which local governments issued official guarantees (2.7 trillion yuan, or $450 billion) and debt with implicit government guarantees (4.3 trillion yuan, or $710 billion). China's local government debt and contingent liabilities grew 67 percent from a previous audit result at the end of 2010, which calculated it to be 10.7 trillion yuan ($1.77 trillion) .
Combined with another 9.8 trillion yuan in direct central government debt, 260 billion yuan ($42.95 billion) in central government-backed debt and 2.3 trillion yuan ($370.1 billion) in debt with implicit central government guarantee, China's total government debt as of June 2013 stands at 30.27 trillion yuan ($5 trillion).
China's new leaders are aiming for a stable growth of the economy as they aim to transform it into one driven by consumption rather than a reliance on investment and exports. But they face a series of challenges, among which the rise of debt at all levels of government is seen as the biggest threat to the country's financial stability.
Under China's laws, local governments are barred from borrowing directly from banks or investors, even though they are responsible for most public spending while receiving around half of the fiscal income. The funding shortfall has forced local authorities to take on debts to pay for public works.
There had been no official update on the extent of the local government debt since 2011. Market fears that China's banking system will be compromised if a portion of the government debt is not repaid were amplified by a dearth of information.
As investors have long viewed China's pile of local government debt as one of the biggest threats to its economy, the new leadership which took office in March 2013 pledged to keep a close eye on the issue and ordered a comprehensive review of all government balance sheets in August 2013, the first such audit since June 2011.
The latest audit is even more comprehensive than the one in 2011 because it includes money borrowed by more than 33,000 township governments. In total, the auditor reviewed the finances of more than 36,000 local government units to compile the figures.
The latest audit shows China's determination to mop up fiscal troubles, giving it needed room to start the other bold financial reforms promised at the Third Plenary Session of the 18th Central Committee of the Communist Party of China (CPC) held in Beijing last November.
The debt load
The NAO said direct government debt at the end of 2012 was 105.66 percent of government fiscal revenue, while a 90-150 percent ratio is considered safe internationally. Direct government debt as a ratio of the GDP stood at 36.74 percent, well below the 60 percent international standard.
In addition, the repayment of government debt is backed by China's stable and relatively fast economic growth. Also, government debt is mainly used for infrastructure construction, which creates a large amount of high-quality government assets that also guarantee the repayment of debts, the NAO commented.