Irregularities in $1.7-trn govt debt, finds China auditor

China’s first audit of local government debt found liabilities of 10.7 trillion yuan ($1.7 trillion) at the end of last year and warned of repayment risks, including a reliance on land sales.

Financing vehicles set up by regional authorities already had more than 8 billion yuan in overdue debt, while more than five per cent of such companies used new bank borrowing to repay loans, according to the audit, posted on the National Audit Office’s website and submitted to China’s cabinet.

“Some local government financing platforms’ management is irregular, and their profitability and ability to pay their debt is quite weak,” Liu Jiayi, the country’s auditor-general said in a speech published today.

Premier Wen Jiabao ordered the first audit of local- government borrowing in March, amid concern spending designed to support the economy following the 2008 global financial crisis would leave a legacy of bad debt. As much as 30 per cent of bank loans are expected to turn sour and they are likely to be the biggest source of non-performing assets for the industry, Standard & Poor’s said in April.

Local governments, barred from selling bonds or borrowing directly from banks, had set up 6,576 financing vehicles by the end of 2010 to raise money, the audit showed, accounting for 4.97 trillion yuan, 60 per cent of which governments have responsibility to repay. Some governments have offered illicit guarantees to such companies, while others rely on land sales to help them repay, Liu said.

UBS AG estimated in a June 7 report that local government debt could be 30 per cent of gross domestic product and may generate around 2-3 trillion yuan of non-performing loans. Credit Suisse AG economist Tao Dong said it was the biggest “time bomb” for China’s economy.

“Overall it seems manageable but the real question: is anyone going to manage it?” said Vincent Chan, head of China research at Credit Suisse in Hong Kong. “Everyone wants to solve the problem on the condition that the other two parties pay the bill.”

The audit showed 80 per cent of local government debt was bank loans and 70 per cent will mature in the next five years.

Qu Hongbin, a Hong Kong-based economist for HSBC Holdings Plc, said the biggest problem was transparency and the mismatch between maturities and projected revenue generation.

“Without real action going towards a restructuring of these debts, banks would face a real risk of defaulting in the coming years,” he wrote in report today.

Governments from 12 provinces, 307 cities and 1,131 townships have pledged to use revenues from land sales to repay a combined outstanding debt of 2.55 trillion yuan. More than 35 billion yuan of money borrowed by local governments went into the stock and property markets or prohibited projects, the report showed. Five of China’s commercial banks have issued 58 billion yuan of loans that violated loan rules, it said.

The yield on the government’s 2.77 per cent May 2012 bonds jumped 41 basis points, or 0.41 percentage point, this month to 3.43 per cent, as the central bank tightened money supply to curb inflation. Twelve-month non-deliverable yuan forwards have dropped 0.7 per cent in June to 6.40 per dollar as of 4:30 pm in Hong Kong.