Fighting local govt debt

Chinese leaders have pledged to tackle the problem of local governments' debts next year and create a stable economic and social environment to promote reforms, according to the statement issued by the Central Economic Work Conference that ended on Friday. This is the first time "controlling and addressing local government debt risks" has been made as an especially important task in economic work.

In recent years, the impact of growing local government debt on the Chinese economy has sparked an intense debate among economists, financial analysts and the investment community. Macroeconomics is, in itself, a fascinating field of social sciences. And as the saying goes, any two economists will have three different opinions on one subject. In the case of local government debt, this seems to apply par excellence. But it is hard to draw conclusions before data of latest overall local government debt is revealed.

There are two main questions that people struggle to come to terms with when it comes to local government debt: What is the actual level of the debt and how this has evolved over time; and what have the returns on local government investments been over time.

By the end of 2010, local government debt had reached 10.7 trillion yuan ($1.76 trillion). The nationwide audit of government debt, announced by the National Audit Office in July, would have given us a better idea of the latest figure but its results are yet to be published. The most recent official data on local government debt, therefore, come from an NAO survey released in June that put the debts of just 36 local governments at 3.85 trillion yuan at the end of 2012, up 12.9 percent from 2010. This is, however, a survey of selected samples, and in no way can be extrapolated to estimate total local government debt.

The answer to the first question is several estimates - the stock of debt - ranging from 12 trillion yuan to 25 trillion yuan, or 33 percent to 50 percent of GDP. However, experts with the Ministry of Finance recently emphasized that local government debt is manageable.

With regards to the second question, that is, what has all this money been used for and what returns have the resulting projects yielded, we enter the realm of pure guesses.

Notwithstanding the perception that something is not working as it should, people should not jump to the conclusion that these are not good investments: China is building a world-class transport infrastructure and it is normal for the returns in the short-term to fall short of expectations, provided they contribute to real economic growth in the longer term.

To get a better understanding of the potential impact that local government debt could have on the future of China's economic growth, investors use the analogy of the corporate sector, because at the end of the day, analyzing a country's financial performance is not fundamentally different from analyzing the financial statements of a company.