Wall Street Journal: China’s Systemic Risk

From an editorial in the Wall Street Journal Asia:

A Chinese financial newspaper last month reported a case in which a Shanghai township took two billion yuan ($293 million) in loans intended for a new railway and instead used the money to repay other debts and invest in real estate projects. While the large sum involved may be unusual, such tales of misappropriation have become more common since Beijing began encouraging bank-financed spending on infrastructure a little over a year ago. Evidence is mounting that the problem of local government debt is already extremely serious and could eventually threaten the country’s financial stability.

Victor Shih, a professor at Northwestern University, wrote in these pages in February that his research put the level of borrowing by local government investment entities between 2004 and the end of 2009 at 11.4 trillion yuan ($1.7 trillion)—or about one-third of annual GDP. That figure stirred up a lot of controversy, with regulators insisting that the loans stood at six trillion yuan.

Beijing has since asked banks for an updated accounting of such debt on their books, however, and it’s looking more and more like Mr. Shih was on the right track. The government has revised up its estimate to 7.8 trillion yuan, and more revisions may come as the banks continue to report. A new report from Goldman Sachs last week implicitly supports Mr. Shih’s calculations.

But the total figure is only important in the context of the trend of new lending and the quality of the loans. And here things get even murkier.

See also “FACTBOX-Key political risks to watch in China” from Reuters.