C&B Notes

Cultural Differences Do Not Abolish Economic Principles

The significant investments that China has made over the past 5-10 years have been fueled in large part by debt.  The Communist party is now forcing banks to roll over the loans made to local/regional governments because these borrowers are currently unable to repay these debts.  The Chinese city of Chongqing is a case study in unsustainable leverage:

The Chinese city of Chongqing accumulated tens of billions of dollars in liabilities during Bo Xilai’s term as local Communist Party chief, as it juiced growth that helped launch the former high-flyer’s campaign for a top political post.

A Wall Street Journal analysis of Chinese rating-company reports shows that 10 major investment vehicles the city used to fuel its growth accumulated more than 346 billion yuan ($54 billion) in liabilities, as it recapitalized banks and built highways, bridges and other projects that boosted growth and helped attract global companies looking for an entry into China’s booming inland markets.  In 2007, when Mr. Bo became Chongqing’s party chief, its top post, those vehicles had total liabilities of 162 billion yuan.

Those debts likely represent only part of Chongqing’s obligations, analysts say, because state-owned enterprises and property developers have liabilities of their own.  The figures also exclude a number of smaller investment vehicles.

“I don’t think it would be a stretch to say that Chongqing local government, state-owned enterprises and state-owned developers collectively owed 1 trillion yuan at the end of 2011,” says Victor Shih, an expert on China’s local-government debt at Northwestern University.  That estimate, based on Mr. Shih’s own look through the records of Chongqing’s financing vehicles, would put local-government debt in Chongqing at 100% of gross regional product, far higher than the 22% level for China as a whole, according to numbers from China’s national audit office.

Additionally, the author makes the point that much of this debt is secured with real estate, indicating that falling real estate prices could lead to a downward spiral revolving around property values, loan defaults, and borrower insolvency.  Sound familiar?

Chongqing offers a glimpse of potential problems elsewhere in China.  Local investment vehicles like the ones in Chongqing became more aggressive after the 2008 financial crisis as the government tried to stimulate growth, leading to an estimated 10.7 trillion yuan in town-hall debt nationwide.  Much of the debt is backed by land, and some observers fear many of those loans could turn sour if growth and the property market slowed.

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