Cover Editorial - EO print edition no. 465
Translated by Tang Xiangyang
Original article: [Chinese]

According to the economic data for the first quarter released by the National Bureau of Statistics on April 15, China's GDP grew by 11.9 percent and the CPI increased by 2.2 percent in March, a better result than many expected and a sign that a steady recovery is underway. However, behind the data, potential risks remain. At a recent meeting of the Standing Committee of the State Council, members indicated that the central government is planning to strengthen management of risk associated with local financing platforms. We believe risks relating to these platforms are increasing and attention should be paid to these risks.

One reason for the above diagnosis is that expectations of inflation have intensified; an over-heated economy is produced by a growing economy and an increasing CPI. Most economic players have predicted the People's Bank of China will lift interest rates in the second quarter of this year. Last week, the State Council issued new policies to curb skyrocketing housing prices. For local financing platforms, this means implicit risks will gradually become explicit .

Together, increasing interest rates and applying pressure on the property bubble form a "double-squeeze" on local governments. The four-trillion yuan stimulus package has been dominated by infrastructure and civil works projects, both of which have a low investment return. When local financing platforms such as urban investment companies are lobbying to get loans and to be authorized to issue bonds for these projects, they not only use the land the local government has provided for the project as collateral, but in some cases local governments also promise to buy back the project in order to ensure its rate of return. For local financing platforms or local governments, their main source of paying off debt relies on revenue gained by selling land. As of late last year, the total number of loans acquired by financing platforms exceeded six trillion yuan.

If the "double-squeeze" continues, the financial cost of projects currently under construction will rise and become a great burden on local governments. Additionally, with reduced liquidity, the revenue gained by selling land will be affected as the central government continues to squeeze the air out of the property bubble. Not only might the chain linking local government funds break, the banking system will also face exposure to a large amount of bad debt.

This is not alarmist, as local financing platforms are managed by multiple administrations, it's difficult for the central government to know their real situation. The central government needs further investigation to see what risks hide behind their deceptively positive data. That's why, currently, the National People's Congress, the National Development and Reform Commission, the Ministry of Finance and the China Banking Regulatory Commission (CBRC) are co-investigating the risks of local financing platforms.

We have learned that the CBRC is reviewing projects run by local financing platforms with a fine-tooth comb by separating the packaged loans of projects and analyzing their economic feasibility one by one, stopping projects with obvious risks. The CBRC also requires that financial institutions do not extend credit to local governments and local financing platforms when a project has not been specified.

All the above measures will be, to some degree, effective. But along with preventing local governments from getting credit, the central government should also provide new financing methods for them. Local government and local financing platform bonds should be made public so that investors may know the risks and local governments may be forced to discipline themselves. Meanwhile, local bonds previously issued by the central government should be issued by the local governments themselves from now on. Only when those bonds have market ratings and are local governments aware of their risks will the behavior of local governments be restrained.

With transparent restrictions and the awarding of rights to impose a reasonable level of proper tax, local governments will no longer suffer from inadequate capital. If these changes are not implemented, things will get worse. Finance Minister Xie Xuren expressed a similar view in his article published in Seeking Truth (Qiu Shi) magazine. Why not start now by taking the first step and making the details of local government bonds public?

This article was edited by Rose Scobie