The debts of local Chinese governments are not huge or risky enough to evolve into a crisis like the one sweeping Europe, but the situation does deserve attention, economists at home and abroad have said.

They also suggested the Chinese government develop a mature and transparent financial market mechanism as soon as possible to prevent local debts from growing and deteriorating.

In early June, a Chinese economist compared local government debt to that in the Eurozone and warned that a Greek-style crisis could erupt on the Chinese mainland if not well managed.

Yet many economists doubt the likelihood of a major crisis. "The nation has a high volume of savings and foreign exchange reserves and fairly stable economic growth," said Zhang Xiaojing, an economics professor at the Institute of Economics at the Chinese Academy of Social Sciences. "Also, the ratio of local government debt to GDP is far less than that of the Eurozone."

Foreign economists agree that excessive worry is unnecessary at the moment.

"My feeling is that local debt levels are a matter of concern, but thankfully China is in a better position than other countries," said Rachel Ziemba, senior economist on China issues at Roubini Global Economics based in London.

While the United States and Europe have seen their economies slow, China's GDP has been surging. During the first quarter the economy grew 11.9 percent, and is predicted to rise more than 10 percent during the second quarter.

The National Audit Office of China announced last week that local government debt in China's 18 provinces hit 2.79 trillion yuan (US$410 billion) at the end of 2009, far less than the predicted US$900 billion by some Chinese researchers.

"Local debt grew rapidly last year, and in 2009 alone, an additional debt of 1.04 trillion yuan was added," said the National Audit Office.

Financial market

Such a huge local government debt was amassed as a result of irrational borrowing by local governments that were too eager to maintain a high level of growth during the financial crisis.

"Adding investment (when economy is low) is a common practice worldwide," said Daniel Schwanen, special advisor to The Center for International Governance Innovation.

But the key to avoiding a crisis is "to ensure that China has a well-developed and transparent financial market mechanism" to supervise the whereabouts and flow of capital and to control the risks, he added.

Under the current regime, China's local governments are not allowed to borrow from banks or issue bonds, which forces them to find alternatives to fund deficits. One way is to establish a local government investment company that can borrow directly from banks.

There were 8,221 such companies as of June 2009. Though there is no official data on the amount of loans these companies have borrowed, Nomura Global Economics estimated the amount was 5 trillion yuan in 2009.

"It is a big question mark whether the local governments and investment companies have the capability to repay, otherwise the commercial banks have to take the risk of writing off bad-performing loans," said Zhang.

According to a Blue Book by the Chinese Academy of Social Sciences last week, the latent risk embedded in the loans might dampen the profitability of China's banking sector by 7.9 percent between 2010 and 2012.

"Some of them (debts) are going to be bad and some less performing, and these can be constraints on China's growth for the next few years. If there is a flattening in Europe it could make China's transition more difficult," said Ziemba.

(China Daily June 28, 2010)