experts say it's essential to use debt funds effectively to solve the hidden debt risks in china

Posted by santillano at 2020-03-03

Beijing, Sept. 12 (Reuters) - it's essential to use debt funds effectively to solve the hidden debt risks of local governments, Liu Shangxi, President of the Chinese Academy of financial Sciences, wrote recently. At the same time, many departments are working hard to curb the growth of implicit debt in an administrative way that is too urgent, which may detonate a risk bomb in advance; if they do their own things to prevent and resolve risks, they may cause huge operational risks.

Data picture: in November 2013, pedestrians passed an elevated channel in Lujiazui Financial District in Pudong, Shanghai. REUTERS/Carlos Barria

According to the article, the current problem is that there is no authoritative definition of local government's contingent liabilities, which leads to unclear base number, let alone calculation and analysis of contingent liabilities' compensation probability, and failure to fully and accurately reveal its risks, which may not only exaggerate the debt risks of local governments, but also reduce the risks. Therefore, at present, we need to coordinate and cooperate more than ever, and we need to coordinate risk prevention and control with the thinking of reform and innovation.

The following is the key summary of the expert article:

To eliminate risks, such as bomb dismantling, requires accuracy and patience. A little careless operation may lead to explosion and crisis. At present, China is facing a wide range of risks, which are interrelated and nested with each other, and become a whole through the chain of credit and debt relations. The risks of real enterprises, local governments' implicit debt, financial risks, real estate risks, family debt risks, etc. are essentially balance sheet risks, which are interrelated. To resolve risks, we should not only look at the surface, but also see the integrity of risks, the penetration and infectivity of risks in various fields. If we do our own thing to prevent and resolve risks, it may lead to huge operational risks. In this regard, we need to pay high attention and be alert. At present, it is more necessary to coordinate and cooperate with each other than ever, and it is necessary to coordinate risk prevention and control with the thinking of reform and innovation.

At present, the transparency of local government debt is like an iceberg. On the surface of the water is the explicit debt, while on the surface is the implicit debt. Its risk is self-evident, especially in the case of the sudden brake of debt management and control. According to the plan of local government debt emergency disposal forwarded by the State Office in 2016, even if some cities and counties have reached the emergency level of launching the "financial restructuring plan", no one is willing to be the first domino to fall under the current accountability mechanism. It is possible to detonate the risk bomb ahead of time if multiple departments work together to curb the growth of implicit debt by means of over acting administration.

Local implicit debt is mainly contingent debt, which mainly includes three categories: first, constructive debt, such as debt of investment and financing platform, debt of shed reform, debt of government purchase service project, debt of government social capital cooperation project, debt of zombie enterprises of local state-owned enterprises, financial poverty alleviation project, etc. Second, consumer debt, mainly the pension gap, has already appeared in more than 10 provinces, and this number will continue to increase. The third is the debt formed by local policy financing guarantee, such as bridge loan, bank and government guarantee, etc.

The current problem is that there is no authoritative definition of local government contingent liability, which leads to unclear base number, let alone calculation and analysis of contingent liability compensation probability, and can not fully and accurately reveal its risks. This may not only exaggerate the debt risk of local governments, but also reduce the risk. In 2014, this problem was faced when auditing local debts. This kind of risk concealment itself is a huge risk. When bombs and watermelons are indistinguishable, policies and measures to prevent and control risks will be aimless. This is related to the imperfection of government accounting standards and the extensive and unprofessional government macro management. According to the general situation, the documents and notices formulated by some departments make regulations and requirements in principle, and the details of policies and operable terms depend on the regulated objects to speculate and comprehend by themselves.

At present, a large number of implicit debts, i.e. the contingent debts of the government, are expanding rapidly. There are at least the following specific causes:

Third, budget constraints are incomplete. The understanding of budget constraints only stays in the currently determined expenditure matters, but ignores the contingent expenditure matters in the process of the government's performance of its functions. Without a mechanism and procedure to reveal the contingent expenditure matters, a large number of "off balance sheet" debts, namely implicit debts, will be generated, hiding financial risks. However, the real environment we are facing is uncertain. All kinds of uncertain factors may cause the government's contingencies and thus generate the government's contingent expenditure. If we ignore this reality, without uncertainty thinking and risk thinking, there will be no mechanism for risk prevention and control in policy formulation and implementation. When the object of budget constraint is uncertain, the constraint will fail.

Fourth, it is hard to predict. Expectations and behavior are closely linked. The lower level is anticipating the change of the higher level policy, and the higher level is anticipating the behavior of the lower level government. The order of macro policy objectives changes, document fights between superior departments, unstable expenditure standards and so on. In the face of many uncertainties, lower level governments cannot form stable expectations and will act in an opportunistic way. The more the subordinates are like this, the more insecure the superiors are to the subordinates, thus making strict regulations, leading to incompatible incentives. In this way, it will fall into the cycle of "one is in disorder, one is dead". Implicit debt is the result of this cycle.

Debt is not equal to risk. The risk lies in the inefficient use of debt. The risk of debt does not depend on the scale of debt, but on the repayment ability in the future. And the ability to repay fundamentally depends on how debt funds are used and whether they are effective. As long as the asset quality is high, the future repayment ability will be enhanced, and the debt risk will not be expanded. Therefore, to prevent and control the hidden debt risk, in the short term, we need to control the increment, balance the changes between the debt growth and the ability to repay, and maintain the dynamic matching between the two. In the medium and long term, the key is to make good use of debt funds to form a virtuous circle between debt and debt bearing capacity.

Specifically, the following points should be paid attention to:

First, debt control cannot be put on the brakes. Some places put accountability risk in the first place, suspend the project, suspend the contract, and make full efforts to repay the debt. This leads to the project funds are not settled, wages are in arrears, and social risks are increased. The damage of government credibility will cause irreparable damage to local development and worsen local business environment.

Second, inventory the assets and liabilities, and prepare the realizable balance sheet by classification and stratification. Assess the local government's contingent debt compensation rate and government contingent expenditure, incorporate explicit debt and implicit debt into a unified debt management framework, optimize and adjust the thinking of "opening the front door and blocking the back door", and give local governments the right to create new financing options under the condition of total amount control. The key point of local government debt management is to build the risk control mechanism of contingent debt, so as to form an actuarial debt management model. The central government should strengthen the management and evaluation of the construction of risk control mechanism of local government debt, and change from direct management of local debt to direct management of local "risk control mechanism", so as to take over local debt.

Third, urge local governments to prepare the overall planning of investment and financing projects, so as to achieve precise financing and precise construction and precise risk control. At present, a large number of local state-owned enterprises in fact assume the role of policy financing institutions. The policy function should be separated and integrated into a unified policy platform institution, and the former financing platform can also be transformed to undertake part of the construction function of local government. For example, the overall planning of investment and financing, as well as the integrated management of financing, investment, construction, maintenance, debt repayment and risk control in specific projects. Change the functions of the government and let professional people do professional things.

Fourth, the prevention of hidden debt risks should be considered in connection with changes in the economic situation and international environment, and should not be isolated. In the second half of the year, the possibility of economic downturn, real estate market changes, financial risk prevention and control, etc., may reduce the critical value of the outbreak of local implicit debt risk. In this regard, we should be prepared with two hands and deal with it with uncertain thinking, so as to obtain the certainty we want. (end)