Local Debts Not to Drag China into a Financial Crisis

As Chinese economy shows signs of picking up, analysts say shadow banking and local government debt, two major financial worries during the past few months, are less likely now to bring down the world's second-largest economy.

While containing financial expansion is vital to keep the Chinese economy healthy, the market was concerned that the transition could mean a hard landing. Recent improvements, however, show the market might have been overanxious.

China's manufacturing activity rebounded into mild expansion after three months of weakness. Major Chinese industrial firms saw their combined profits rise 11.6 percent year on year in July, quickening from the 6.3-percent rate seen in June.

Economists said the improvements followed easy money at the beginning of the year as well as the government's moves to stabilize growth.

"The Chinese economy is shifting gear. But it doesn't necessarily mean it will stall. If so, market confidence will be badly hit. We can not stimulate the economy blindly, nor can we let the growth drop below a reasonable level," said Wang Yiming, deputy director of academy of macro-economy at the National Development and Reform Commission (NDRC), China's top economic planner.

"Some problems accumulated in the high-growth era will be exposed when economic growth slows," Wang added.

A credit crunch in June alerted investors to China's financial woes. Interbank lending was nearly frozen when 7-day Repo Rate and Shanghai Interbank Offered Rate (SHIBOR) shot up to double digits.

Shadow banking, especially wealth management products (WMPs), were pinned main causes for the money shortage.

Economists feared the shadow banking nerves, together with massive local government debt, might trigger a financial crisis as China's economic growth slowed down to 7.5 percent in the second quarter, a rate much lower than the two-digit growth seen in the past three decades.

Shang Fulin, chairman of the China Banking Regulatory Commission, said most trust and wealth management products strictly regulated, and the risks of shadow banking were controllable.

Meanwhile, local government debt, though rising despite rigid curtailment, could be effectively resolved, some analysts claimed.

Chinese local governments had amassed 10.7 trillion yuan (US$1.7 trillion) debt at the end of 2010. According to an audit of 36 local governments by the National Audit Office, their debt increased 12.9 percent from the end of 2010 to the end of 2012.

"Even though, there are not many bad debts among the massive government debt," said Lin Muxi, an economist at Liaoning University.

"Many debts are related to good assets, like transportation infrastructure and affordable housing projects. The terms may be long, but the debts are repayable," Lin said.

Song Li, vice director of the research center of economy at NDRC, said Chinese local governments were caught into a liquidity issue, but the issue would only be short-term.

"What Chinese local governments encounter are financial problems, so we need to look at local debts more objectively," he said.