Saturday, Jul 22, 2017, 8:50 AM CST – China

Commentary

China needs to solve its debt problem

Deleveraging debts is key for China’s economic future

Recently, in a September 10 speech at the annual World Economic Forum meeting known as the Summer Davos, Chinese Premier Li Keqiang said that China was responsible for around 30 percent of global economic growth in the first half of 2015, stressing that the Chinese economy will not suffer a “hard landing.”

Despite Li’s confidence, China’s local governments’ debts, which are a major threat to the country’s financial stability, appear to be swelling. According to data recently released by the government, China’s local governments owed a total of 15.4 trillion yuan (US$2.42tn) at the end of 2014, an increase of 41 percent compared to the figure from 18 months before. Experts believe that the increase is largely due to the fact that local governments have stopped trying to hide debts from the central government, as the latter recently offered to swap some of the former’s existing high-interest debts for low-cost bonds.

Even so, the existence of huge local debts will continue to present a major threat to China’s financial and economic well-being for quite a long time. The Chinese government must find a solution to gradually deleverage its existing debts so that a potential bomb within the Chinese economy can be defused.

The importance of deleveraging debts becomes clear through situations faced by the US and the European Union. During the global financial crisis that hit in 2008, the US government launched monetary quantitative easing and purchased a huge amount of toxic assets from troubled financial institutions, which effectively lowered the leverage ratio in the financial sector. Partially due to the deleveraging, the US economy gradually recovered from the financial crisis.

By contrast, the EU refused to take drastic measures to deal with its recent debt problems, which only prolonged the issue, leading to the Greek debt crisis. Eventually, the EU also decided to resort to quantitative easing to deleverage debt.

To alleviate its growing debt, China has adopted measures that are, to a certain extent, similar to those the US adopted during the global financial crisis. To stabilize the market, the US used quantitative easing and allowed troubled financial institutions to offload their toxic assets. Similarly, China’s central government has offered to take over the debts from local governments by offering them low-interest bonds, transferring the risk from the local government to the central government which has more resources to deal with the issue.

However, given the size of the existing debt, low-interest bonds from the central government will not be adequate to solve the problem. With a volatile stock market and an overheated real estate market, China must find alternative ways to inject more funds into the economy.

Firstly, China needs to push forward reforms regarding its State-owned enterprises (SOEs), which are directly related to the country’s debt problems. The reforms should not be about acquisition and expansion, like what happened in previous reforms, but about allowing private capital to invest in the industries monopolized by SOEs.

Secondly, China should expand the application of the model of public-private partnerships (PPP) to increase the efficiency of the use of funds at the local level. However, in doing so, the government should be careful to make sure projects are completed without adding to the already sizable amount of local government debt.

Finally, China should address various problems that concern private investors, such as the government’s at times unpredictable and arbitrary attitude toward PPP endeavors and the transparency of projects’ legal status, to truly allow the market to play the dominant role and establish the oft-cited “rule of law” in the business world.

Only in this way can China effectively deleverage its debts in the context of a weakening economy and secure its long-term economic prospects. 

The author is an associate professor at the Central Party School.

 

The existence of huge local debts will continue to present a major threat to China’s financial and economic well-being for quite a long time

 

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