China's direct govt debt risks controllable

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 December 13. The conference traditionally sets the tone for following year's economic policy.

Lu Ting, chief China economist with 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.