China contains local govt debt

BEIJING - Chinese leaders have made cleaning up government debt a crucial task for next year, threatening to tighten fiscal discipline to defend financial stability.

Resolving risk associated with local government debt was a main theme of the Central Economic Work Conference that ended last Friday. The conference traditionally sets the tone for following year's economic policy.

Local government thirst for borrowing grew during the investment and construction binge that was part and parcel of a stimulus in 2008 to buffer against the global financial crisis. Since then, officials across the country have vied with one another to launch heavy industry and infrastructure projects that ensure skyrocketing economic growth and thus a fast track to promotion. A substantial proportion of the money invested was borrowed.

During the conference, the central leadership resolved to change an administrative mindset obsessed by GDP growth, only days after the Communist Party of China decided on a new system to evaluate officials, which includes local government debt as an important indicator.

"Designating government debt as a key task is a response to market concerns," said Ding Shuang, Senior China Economist at Citi. "It's expectation management, telling the market that local government debt will not expand without restraint."

"The risks are not impossible to diffuse if the central government pays adequate attention," Ding added. "The implied scenario here is to first tackle the increment. If the debt stops ballooning, China's debt level will decrease as its GDP grows."

Escalating local government debt has raised concern that hidden debt problems could bring instability to the banking system. so China's policymakers are vigilant against financial risk.

The National Audit Office (NAO) estimates local government debt at around 10.7 trillion yuan ($1.64 trillion) by the end of 2010. As the government debt level kept rising, the NAO announced a nationwide audit of government debt in July, but the results have yet to be published.

Many local government financing vehicles (LGFVs) have seen their cash flow stagnate or decline, while their debt levels have risen, according to a report released by Moody's earlier this year.

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