Buildings Brics: The building boom across vast swathes of China continues unabated, with countless hundreds of towerblocks, signature infrastructure schemes and other developments transforming the landscape.
Fears over China's banking bubble
The building boom across vast swathes of China continues unabated, with countless hundreds of tower blocks, signature infrastructure schemes and other developments transforming the landscape.
Yet questions are growing about whether local governments in particular have overreached themselves in funding the projects.
China's local authority debt has been branded "toxic" in reports, amid concern the trillions of yuan borrowed could lead to a crisis in the banking system as the number of non-performing loans (NPLs) increases.
"The local government debt risk is pretty substantial - over 20 per cent of GDP," says Ren Xianfang, a senior analyst at IHS Global Insight in Beijing.
There is a risk these loans could cause the "implosion" of China's commercial banking sector", Ms Ren warns.
"The worst-case scenario is that the banks will have to be restructured just as they did in the late 1990s and early 2000s," she says, with large amounts of national wealth being used to recapitalise the banks if this chain of events occurred. This could eat up government savings that could have been spent on health care and social welfare projects.
One of the most severe predictions came from Jim Chanos, of the hedge fund Kynikos Associates, who recently said China's banking system was "built on quicksand".
In October, Credit Suisse announced much higher estimates of the risk of NPLs affecting Chinese banks, citing manufacturing, property and small and medium-sized enterprises, as well as local government, as key concerns. NPLs, the company said, could translate into two-thirds to 100 per cent of the equity of banks.
Much of the debt stems from infrastructure spending, with authorities setting up thousands of off-balance-sheet local government financing vehicles to borrow money as a way around restrictions on their taking out loans directly or issuing bonds.
An estimate from the credit ratings agency Moody's put the total amount of debt at as much as US$2.2 trillion (Dh8.08tn), with the investment bank UBS warning $460 million could end up as defaults.
Many developments are thought to have limited revenue-generating capacity, especially if economic growth slows. Problems will become particularly acute if property prices tumble, as many loans were taken out using land as collateral.
No wonder that last month the IMF warned of "a steady build-up of financial sector vulnerabilities" in China.
According to China Inside Out, an HSBC report released this month, local governments are facing "a real liquidity risk in the coming years" and the central government will have to take "decisive action to restructure debt to prevent a major bank default" because almost a quarter of this debt matured this year, and close to one-fifth matures next year.
Amid the concern, there are reasons for optimism. Thanks to the healthy state of the Chinese central government's finances, with foreign exchange reserves of more than $3tn, risks can be minimised, according to Donna Kwok, a greater China economist with HSBC.
"I think it's a situation under control," she says, adding the central government should be able to "contain and manage" the situation.
One way to deal with the debts, HSBC suggests, is to extend nationwide a trial programme that has seen local authorities in parts of China, including Shanghai and Guangdong province, issue municipal bonds valued at billions of yuan and with maturity periods of up to five years. Also, the bank points out that local governments own more than 20,000 state-owned enterprises, more than 70 per cent of them profitable, that can help finance debt repayment. In addition, some infrastructure projects are already generating revenue.
"It's a long-term problem that has to be dealt with a long-term solution," says Ms Kwok.
Given how low overall public-sector debt is in China, there are many solutions to dealing with the loans made to local authorities, says Li Cui, the chief China economist for the Royal Bank of Scotland. The central government can simply take over the debt itself, for example.
Central government debt, Ms Li says, is less than 20 per cent of GDP, and if all other types of borrowing are added, such as by local governments and to pay for high-speed railways, the figure adds up to about 70 per cent of GDP.
"At least half of that is balanced by infrastructure projects, so the government doesn't need to step in unless there's a shortfall on these cost flows," she says.
As direct public sector debt is modest and growth high, Ms Li says the authorities have "a lot of reach" to absorb NPLs from banks.
"If the government rolls it over and takes it on to its balance sheet, it's a more direct expression of that cost through the public balance sheet, rather than sitting on banks' books," she says.
"We have to look at the government balance sheet in its totality and see whether it can afford to do it. I think it can afford to do it, to roll over the debt."
Concerns remain, however. Ben Simpfendorfer, who runs Silk Road Associates, an economic consultancy, says the debt is not going to result in "a Greece-style collapse", but is nonetheless "a serious issue".
The interior provinces, where debt levels are especially high, are key drivers for China's economic growth, so if they suffer problems, Mr Simpfendorfer believes there could be a major effect on national GDP increases.
Similarly, local governments themselves have been important contributors to growth through their infrastructure spending, and the small and medium-sized enterprises sector is not well enough developed to replace them as growth drivers.
"The biggest risk will be what happens if GDP growth was to slow markedly and the government found it difficult to bail out the banks," Mr Simpfendorfer says.
While saying this scenario is not likely for a few years, Mr Simpfendorfer cautions the issue could contribute to China's annual growth falling to as little as 5 per cent.
The wider consequences of this could be significant, as 8 per cent growth is often cited as being necessary to create opportunities for all those coming on to the job market each year.