China’s Local Debt Problem Needs Political, not Economic Solution

China’s Local Debt Problem Needs Political, not Economic Solution

BEIJING -- Since 2009, China's credit-fueled economic stimulus plan has dramatically increased overall indebtedness and created new risks to long-term headline growth. Among the most acute of these is mounting local government debt, which has tripled as a percentage of GDP since 2008 amid a carnival of inefficient spending. Clearing up the mess has emerged as a key challenge for maintaining strong economic growth. However, the solution is as much political as economic and requires a fundamental rebalancing of the power relations between central and local government.

Compared to most developed economies, China's national debt levels remain low at around 70 percent of its annual GDP. This figure is rising rapidly, roughly doubling since 2007 and on course to reach 100 percent as early as 2013. However, while rising overall indebtedness is a cause for concern, if current growth rates are sustained, the expansion of lending per se should be manageable.

Reports that Beijing might "repackage" some of its toxic debt have prompted comparisons with the 2007 American subprime bubble. But the comparison falls short since the risk of default is actually relatively small due to the cosseted nature of China's financial system. These debts are not ultimately vulnerable household loans, but agreements between various governmental and quasi-governmental organizations that are effectively underwritten by the state. Moreover, none of the banks tasked with repackaging the loans will have an interest in simultaneously shorting them.

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