The China Collapse trope is rearing its ugly head again. This time round, the spin is on China’s local government or municipal debts.
The latest narrative goes like this : local governments in China are estimated to have hidden debts of 40 trillion Yuan (or $6 trillion). Those hidden or undisclosed debts, together with outstanding municipal bonds and the Central government debts, “could have reached an alarming level of 60%”. The 60% debt to GDP ratio is hardwired in the Maastricht Treaty with a view to instilling fiscal and financial disciplines among the 28 member states of the European Union or EU 28 for short. The S&P report describes China’s hidden municipal debts as “a debt iceberg with titanic credit risks”!
Now, let’s unpack the opinion in the S&P report.
Estimates of China’s hidden municipal debts range from 8.9 trillion Yuan by Bank for International Settlements and 19.1 trillion Yuan by IMF to 23.6 trillion Yuan by Chinese Academy of Social Sciences and 47 trillion Yuan by Tsinghua University Taxation and Finance Research Institute. There are 8 different estimates by 8 different institutions, with the median value of 30 trillion Yuan. S&P didn’t explain or justify its choice of 40 trillion Yuan, which is close to the top outlier of 47 trillion Yuan.
Based on the median value of 30 trillion Yuan in undisclosed municipal debts, the total Central government (13 trillion Yuan) and municipal debts (including the disclosed portion of 16 trillion Yuan) stood at 60 trillion Yuan (about $9 trillion) at end 2017. That works out to 73 % of China’s nominal GDP of 83 trillion Yuan ($12.4 trillion) in 2017.
The 60% debt to GDP prescription in Maastricht Treaty is more honored in the breach. The average debt to GDP ratio of EU 28 by end 2017 is 81.6%. Even the EU discipline master Germany’s 64% exceeds the 60% limit! The financial situation in a handful of EU states is precarious, even parlous. Their debt to GDP ratio is not just alarming, but downright frightening :
Greece 180 %
China’s total public debts including those of municipalities are nowhere near distress levels, nor excessive by international standards. Several advanced economies have way higher debt to GDP ratio, in addition to the 6 EU states above :
US 102% (111% including municipal debts)
Unlike most other countries, China has ample assets and funds in the public coffers. Apart from $3.1 trillion in foreign reserves (the most in the world, making it the biggest creditor nation), state-owned enterprises have net worth of another $3 trillion, $2 trillion of which is in the form of SOE shares listed on stock exchanges.
Most of the Chinese municipal debts were incurred to build public amenities and infrastructures to attract and support local and foreign investments. Such productive use of debts will yield a return over time in the form of taxes paid by businesses out of their profits. By comparison, most of the debts of developed countries and their municipalities go towards operating expenditures.
The risk of default by Chinese municipalities on their debts, disclosed and undisclosed, is remote. Most of the loans are from state-owned banks. It’s all in the family.