The art of maintaining a healthy debt

The Third Plenum of the 18th Communist Party of China Central Committee issued a communiqu in November saying local governments could issue bonds to generate funds. A month later, the Central Economic Work Conference said minimizing local governments' debt risks would be one of the major economic missions in 2014. This shows the country's leadership is determined to resolve the local governments' debt (LGD) issue.

According to latest National Audit Office data, the total amount of LGD, both direct and guaranteed, is 17.9 trillion yuan ($2.96 trillion), or more than 30 percent of China's GDP. To make matters clear, let us check LGDs in some other countries. Japan's LGD has increased from 40 percent of its GDP in 2000 to nearly 200 percent today. Greece has a ratio of 60 percent, Italy and Portugal 120 percent, and Spain, the UK, France and Germany between 80 and 90 percent. This means China's LGD is less than that of Japan and European countries.

But compared with the United States, China's LGD is very high. Although the US federal government's debt was 108 percent of its GDP, its local governments' debt is quite small. For example, at 13 percent the state of California has the highest LGD-to-GDP ratio. Half the states in the US have a debt ratio of less than 1 percent, with one-fourth of those with less than 0.5 percent.

Almost 70 percent of China's LGD was created within five years. Bank loans play an important role in increasing the debt, accounting for 80 percent of the total. Besides, local financing vehicles are to be blamed for 46 percent of the LGD, with the debt-to-GDP ratio in some provinces being as high as 150 percent, or even over 200 percent, if their disposable incomes are taken into account.

Although such a high ratio can be attributed to China's fiscal system in which the central government collects the chunk of fiscal revenue and then transfers the share of the local governments, the current ratios are much higher than five years ago.

LGD has ballooned because local governments need to spend more money, mainly to build and develop infrastructure, including highways, parks and drainage systems, and protect the environment. They also have to use funds to build and maintain more educational and medical institutions. The situation was not very different in other countries during their developing period.