Analysts at NAB remained concerned about the buildup of excessive leverage in China’s opaque financial system.
In particular, they said a troubling debt buildup at the local government level leaves China particularly exposed to any property downturn.
NAB said the issue has been lingering since 2013, after local governments used debt to carry out an infrastructure push at the directive of Beijing in the wake of 2009’s global financial crisis.
“This saw total outstanding debt reach 24 trillion renminbi at the end of 2014 (around $US3.8 trillion) compared with just 4.5 trillion renminbi prior to the crisis.”
However, “there remains significant uncertainty around local government debt, as data for the overall figure — including obligations where the government has provided a guarantee against the borrowing — has not been updated since late 2014”, NAB said.
In response to 2013’s debt concerns, Chinese policy makers authorised municipal bonds to help plug a cash-flow gap for local governments.
But in addition, there’s been a rise in the use of public-private partnerships for the completion of local government projects.
“While these programs were initially endorsed by Beijing, concerns have been raised recently that abuses of the program have merely allowed the expansion of hidden debt for these authorities.”
Importantly, NAB said that local governments will remain dependent on revenue from land sales to keep debt levels under control.
And it’s an area NAB highlighted as a key concern over the next two years.
“There is a crucial connection between local government debt and the real estate sector – with land sales a major source of revenue to service this debt,” NAB said.
“Land sales rose strongly in 2017, accounting for around one-third of total local government revenue.”
“However, we would expect property developers will demand less land in 2018 (and potentially next year as well) as slowing sales flows through into weaker construction activity.”
And according to NAB, that could weigh on government revenues just as more than $US300 billion of debt is set to mature — up from around $115 billoin in the previous year.
The analysts proposed a solution to China’s local government debt woes via the introduction of a long-touted property tax as an extra source of revenue. However, they said the implementation of such a measure is likely still a few years away.
“There are a number of design considerations – such as whether should it be implemented on all properties, or only investment ones — and how to assess an appropriate property value, given several years of volatility in prices,” NAB said.
Turning to household debt levels, the analysts noted that Chinese household debt has risen from around 20% of GDP in 2007 to almost 47% in Q2 2017.
“It’s worth noting that these debt levels are well below those of advanced economies – at around 75% of GDP in Q2 2017 – however the gap has narrowed substantially in recent years,” NAB said.
The increase in leverage leaves both local governments and Chinese households more exposed to any movements in China’s property market.
“Beijing will need to carefully manage debt and revenue related risks for local governments until a more sustainable funding source, such as the proposed property tax, can be implemented.”