Authorities have enough assets to repay, finance ministry says

BEIJING - Local government debt is "controllable", the Ministry of Finance said on Monday, easing fears that bad loans could derail the world's second-largest economy.

"Judging from the audit results, local government debt is, generally, controllable, though there are potential risks in some areas," the ministry said in a statement posted on its website.

Local government debt hit 10.7 trillion yuan ($1.7 trillion) at the end of 2010, or about 27 percent of China's gross domestic product, according to a report from the National Audit Office (NAO) on June 27.

The Ministry of Finance said that local governments have enough resources to act as buffers to potential risks. "When you look at their ability to repay debt, apart from fiscal income, local governments have fixed assets, land, natural resources and others," it said.

The State Council, or the Cabinet, vowed in July that it would continue to clean up local government financing and said it would look at setting up a mechanism to regulate the way they raised money.

Local authorities borrowed heavily through corporate bodies they created, to meet borrowing standards set by banks, to finance infrastructure and other projects.

Excessive borrowing, however, sparked concerns that the debt may threaten the financial stability of the economy and ultimately cause economic collapse.

Zhang Shuguang, researcher at the Institute of Economics at the Chinese Academy of Social Sciences, said that though the overall debt risk is under control, there might be a "structural crisis".

"Debt repayment is heavily dependent on land sales," Zhang said, adding that nearly 40 percent of all local governments have promised to repay their debt with money raised from land deals.

Land sales have declined 11 percent year-on-year in the first five months of this year. And as tightening policies targeting real estate are poised to continue, land sales may even drop further.

"If land-based finance continues to worsen, a large crisis may loom," Zhang said.

By the end of 2010, there were 78 cities and 99 counties whose governments were on the verge of bankruptcy. This means that they had a debt ratio of more than 100 percent, debt exceeded revenue, according to the NAO report.

Some, in fact, have already defaulted. A local company in Yunnan province, acting as the provincial financing vehicle, said in April it could only repay the interest but not the principal of its debt, standing at billions of yuan. The provincial government then injected 2 billion yuan ($313 million) into the company.

While the problems are serious, they can be overcome, analysts said.

"Yunnan's case is not unique... but it is not too serious," said Wang Tao, chief China economist at UBS Securities.

Wang said that the financing vehicles of most local governments are facing a problem of cash flow rather than insolvency.

"They may not be able to repay the principal, but if given more time to raise money, most companies can avoid bad debt," Wang said.

The debt will not lead to a hard landing for the economy, or severely damage the banking system, Wang said.

Zhou Qiren, a professor of the National School of Development at Peking University, held a similar point of view.

"There is regional disparity in China, therefore a single case will not likely trigger a national chain reaction," Zhou said.

"But even if there is no immediate concern, it is still a worry in the long term," said Jia Kang, director of the Research Institute for Fiscal Science at the Ministry of Finance.

Jia has repeatedly called for a more transparent financing system for local governments to tackle corruption.

"More attention should be paid to the 'invisible debt'," Jia said. "Invisible debt" is money that has been lent but does not have any official documentation.