China’s Local Debt Problems May Mean Further Privatization

March 19, 2012 Posted by China Briefing Reading Time: 2 minutes

Mar. 19 – China will resort to “market-oriented” measures to tackle its local debt issues, Chinese Premier Wen Jiabao said at a press conference last Wednesday after the closing of the Fifth Session of the Eleventh National People’s Congress. Wen’s remarks have signaled that China may allow more private investors to buy out some of the country’s state-owned assets.

When answering a question raised by Reuters on local government debt, Wen said the government attaches great importance to the debt issues and will not allow those issues to adversely affect China’s development. With regards to debt repayment, some of the debts borrowed for high-quality projects can be repaid by the projects’ own profits, and those used on projects for public interest will be repaid by both the central and local governments. China will also consider market-based approaches such as asset disposals, project transfers and equity sales during the debt repayment process.

That being said, private investors may have a chance to share a stake in the sectors that are mainly controlled by state-owned enterprises (SOEs) at present. The government seems willing to rethink the roles of state and private capital in industries, as the total amount of local debt runs high and risks in debt repayment grow.

Leo Zhang, chairmen of China-based Jumbo Consulting, believes the government should play a smaller part in specific industries.

“In industries where you can exit, you exit…Why do we need over 100 SOEs? It’s unnecessary. You should sell them all,” Zhang commented.

During the past wave of privatization back in the 1990s, China significantly shrunk the state’s stake in enterprises. However, the government still keeps an iron grip on sectors that it regards as “strategically important,” such as energy and finance.

Problems associated with strong state control – which often lacks full consideration to economic efficiency – have gradually risen to the surface. Analysts believe around 20 percent to 30 percent of the over RMB10 trillion in local debts will face a repayment challenge and most of those non-performing loans will be on the books of China’s big banks. While those banks which see weakness on their balance sheets recently started a new round of capital raising, it is again the large SOE-linked buyers who have helped pay most of the bills.

Some of the other government-controlled sectors – such as infrastructure development and power generation – are very attractive to both domestic and foreign private investors. As the world’s second largest economy, China’s spending on infrastructure is multiples of what is being spent anywhere else in the world, but private investors’ participation in this sector remains minimal.

While the Chinese government has come up with various approaches – such as extending the loans’ maturity period and raising more capital – to avoid a major bank default, faster privatization might be the ultimate measure that helps the country finally get away from a vicious lending and spending cycle.

David Roseman, global head of infrastructure, utilities and renewables at Australian investment bank Macquarie Group, offered an example on how more entrepreneurial activity will generate a virtuous cycle. By selling profitable infrastructure to investors, China could free up enough cash to build a toll-free road.

However, the goal for further privatization will not be an easy one to achieve. The complicated ownership structures may make it difficult for SOEs at different levels to agree on asset deals, and their growing financial power – a result of expansion at home and abroad – is also making them less willing to conduct restructuring.