China's direct gov't debt risks controllable

China disclosed its total government debt on Monday and said that debt risk was under control.

China's total public debt to GDP ratio is about 53.3 percent, with 31.5 percent of that attributed to local government debt and 21.8 percent down to the central government, said Lu Ting, chief China economist with Bank of America Merrill Lynch, in a research note.

"We believe the markets and the Chinese government should be alarmed by the rapidly rising leverage, but we do not believe China is on the brink of a debt crisis," he wrote.

Rising government debt

The National Audit Office (NAO) said on Monday, after two months of nationwide audits in August and September, that governments in China were liable for a total direct debt of 20.7 trillion yuan (3.4 trillion U.S. dollars) at the end of June, up 8.6 percent, or 1.63 trillion yuan, since the end of 2012.

Total debt guaranteed by governments at various levels amounted to 2.93 trillion yuan at the end of June. Over and above this amount, debt which governments might have some liability for amounted to 6.65 trillion yuan.

In breakdown, direct central government debt stood at 9.81 trillion yuan the end of June, up 4 percent (375 billion yuan) on the end of 2012. Treasury bonds, loans from international financial institutions and foreign governments account for nearly 84 percent and should be paid by the central budget.

The remaining 10.89 trillion yuan was borrowed by local governments, an increase of 13 percent (1.25 trillion yuan) over the end of 2012.

The debt guaranteed by the central government was 260 billion yuan; debt guaranteed by local governments, 2.67 trillion yuan.

While debt for which the central government might shoulder some of the rescue burden stood at 2.3 trillion yuan in June. That for local governments amounted to 4.34 trillion yuan.

Regarding local government debt, direct debt borrowed by the 31 provincial-level regions totaled 1.78 trillion yuan.

The 391 prefecture-level cities had borrowed a total of 4.84 trillion yuan and about 2,778 counties owed a total of 3.96 trillion yuan, according to NAO. The remaining 307 billion yuan was borrowed by 3,3091 towns nationwide.

Risk controllable

Risks of government debt are generally controllable, but there are some risks in some places, the NAO statement said.

Over the past year or so, the market has been worried by China's rising debt burden and leverage, and there had been no official update since 2011, when the NAO put local government debt around 10.7 trillion yuan at end of 2010.

Local government debt exploded during the investment and construction binge that was part and parcel of a stimulus in 2008 to buffer against the global financial crisis.

The NAO said central authorities took the problem of government debt very seriously, and governments at various levels had made some progress in paying back some debt and regulating local government financing vehicles.

A huge number of debt-financed projects have not generated any cash flow. Local government debt has become a major threat to financial stability.

Resolving risk associated with local government debt was a main theme of the four-day Central Economic Work Conference which ended on Dec. 13. The conference traditionally sets the tone for following year's economic policy.

Lu Ting, of Bank of America Merrill Lynch, maintains China won't face an imminent debt crisis for five reasons -- a very low debt-to-GDP ratio at 21 percent for China's central government, almost all government debt denominated in the Chinese currency Renminbi, huge national savings and quite large good assets owned by governments at various levels.

In addition, China still has high economic growth and fiscal revenue growth despite the slowdown, he said.

Lu, however, warned of a number of rising issues.

Growth of debt has been significantly higher than economic growth in the past two years.

Public debt is dominated by local government debt with significant duration mismatches.

China's 111 percent corporate debt-to-GDP ratio is higher than many other developed economies, due mainly to the weak equity capital market which cannot raise enough capital to support growth.

To solve the problems, Lu suggested China should deleverage its local governments while leveraging up the central government, and should try to replace local government short-term bank and trust loans with longer bonds.

"To maintain both economic growth and financial stability, China should avoid simplistic deleveraging and debt reduction," he added.