China Radio: Local Government Debt
Yesterday, I was on China Radio International talking about rising concerns over local government debt in China — how serious of a problem is it? My fellow guest on the show was Professor He Ping, a colleague from Tsinghua University. You can listen to the hour-long discussion by clicking here (select the first hour of the program).
One point that I think is very important, but only had the chance to mention once, and very briefly, during the program, is that despite all the attention they are getting, LGFV (Local Government Financing Vehicle) loans are only one of many categories of risky loans that have the potential to impose serious losses on China’s financial system. In fact, in the early days of China’s stimulus-inspired lending boom, in Spring 2009, China’s bank regulators clearly considered loans to local government-sponsored infrastructure projects among the least risky loans taking place, arguing that it made little sense to set aside loan loss reserves against them since they were virtually certain to be paid back. The fact that the least risky category of lending is now generating such concern is itself a reason for real concern.
Patrick Chovanec 
I’m hoping you can do a future post on what would happen to personal savings accounts in the case of Chinese bank collapse. I’ve heard bits and pieces, but would like to hear more from you.
I absolutely agree with you Patrick. And really, no one seems to be able to define what a LGFP is. How do these companies vary from a municipal or county SASAC owned commercial enterprise? Not as easy to define as you would think, which I believe is part of the reason for the moving target on debt levels in this sector. Clearly, highway companies are a concern. Subways? Clearly. But what about airports? Bus companies? Seaport authorities? Water companies? Gas? How about a locally owned power company? I have heard people say it has to be infrastructure related. Others say it must serve a social benefit (commercial enterprises don’t?) Some say it must have elements of a subsidy from the government. That becomes circular when you layer in the next test which is cash flow without subsidy. Furthermore, most of these entities are taking down loans for long term projects, whose repayment is based entirely on projections. I never saw a projection submitted by a borrower that does not show enough cash flow to service the debt. Lastly, the CBRC is not consistent in its classification (of LGFP vs commercial)across its geographic branch offices. Shanghai CBRC is easy. Others are not so easy.
But the really big risk in my mind is commercial/industrial lending. There has been an absolutely massive increase in capacity build over the last 2 years and there is no place for this product to go. Recently, I saw an article about how some large industrial SOEs are getting into the warehousing and logistics businesses. Could be a place to house all the inventory they can’t sell.
Sorry for the change of subject but I have a theory about corporate economists that work for companies with substantial mainland interests. They’re positions on inflation abating are never defended with any kind of coherent logic. Indeed, rarely is there ever a reason given for why the say “inflation has peaked”. You have bravely spoken out on this and I commend you for it.
Could the strange behavior of these economists be a result of a backroom chat with mainland officials? A little pressure to lighten up on the inflation out of control rhetoric, eh? I can imagine the message, “if your company wants to be successful here in the mainland, you will support the official line that inflation is under control. Do not say that price increases will continue into the future.” Look at what they did when Unilever announced they were planning a price increase. It wouldn’t tkae a lot to convince these financial companies to stifle their economists. What do you think?
Hua Qiao,
There are about a million reasons to not listen to what iBank, consultancy, or hedge fund economists say. Primarily they are all trying to sell their bullish position to attract more business for themselves. Other times they are protecting their critical customers from negative reviews. And some other times they are just fools who have worked themselves into high positions.
It is fairly clear that what you outlined is precisely what is going on, combined with a splash of what I mentioned above.