Like American cities, Chinese local governments are legally required to balance the budget each year.And like American cities, Chinese local governments are running way over budget: Eighteen provincial, 16 city and 36 county-level governments racked up debt of $412 billion last year, according to Asia Times. Counting debt that is hidden through local investment companies, local debt could be much higher: $1.7 trillion by 2012, Northwestern’s Victor Shih says in Asia Times.
This level of local debt, which is one third of GDP, could cause a large-scale financial crisis, Shih says. It also cripples Beijing’s attempts at fiscal sanity:
“The macro-economic instability stems from the ineffectiveness of our macro-economic management tools. For example, interest rates can be used by the governments as a way to help the economy operate at optimum levels. However, when [local] governments are involved in borrowing and investing through their investment vehicles, which are companies without much worry about repayment or inflation, the effectiveness of macro-economic policy will be impeded,” Shi said.
Local debt is especially bad due to communist policies that mandate growth:
“There is an even worse scenario. Unlike Western market economies, local governments in China have a duty to shore up growth. If the governments do not abide by the Budget Law and fund their pet projects to maintain growth regardless of the projects’ future profitability, while state banks lend to government companies regardless of their ability to repay, the lending spree will backfire, with a soaring number of non-performing loans, and affect currency stability.”