When Beijing unleashed its titanic stimulus in 2009, the priority was to funnel money into the provinces at top speed to power the post-crisis recovery. Local governments and municipalities were allowed to bypass normal borrowing constraints to kick-start projects. Now the reckoning is in and the scale of the credit frenzy risks leaving many of the borrowers in default of loans, more than half of which fall due within three years.
In this context, Beijing chose to order banks to roll the loans over, rather than to bail out the local governments itself. This does little more than win a bit of time. At some stage China’s banking system will have to recognise that bad loans were granted in the rush to stimulus. If the decision is to do more than simply delay the evil day, then the time gained now must be used to set local finances on a sounder basis and to halt the inefficient projects that many of the loans have financed.
And they are legion. Some officials estimate that roughly 25 per cent of projects generate no revenue. Since 2007, local government debt has trebled to more than a quarter of China’s gross domestic product, largely because of the cost of stimulus. Much of this is short-term bank debt, lodged in off-balance-sheet vehicles, designed to circumvent the rules. It is sensible for the government to look for ways to deal with the mismatch of short-term bank funding and the long-term nature of the infrastructure projects it finances. Last year’s decision to allow some provinces and cities to issue bonds is a good first step. Bond issuance encourages transparency and fiscal probity. But the experiment remains limited and the bond market itself is stunted by too many regulatory agencies.