Last week, Reuters reported China is contemplating a bailout of its local government’s bad debts, possibly starting as soon as this month and concluding by year end. As of this writing, the Reuters report is unverified (and China’s Ministry of Finance has denied the assertion), but media chatter has increased on the subject.
According to the report, local governments have roughly 10 trillion yuan (~$1.5 trillion) in debt, and the government expects roughly 20% to go bad (~$300 billion). The report suggests China is reviewing a number of options, including:
The report further suggests that, following the bailout, local governments will be allowed to issue bonds (similar to municipal bonds) rather than rely on loans from the state-owned banks. (China’s market for municipal-like bonds is basically non-existent as of now.)
We’ve long taken China’s loan statistics (including bad loan data) with many grains of salt, but this report is difficult to verify to say the least. Even so, a recapitalization wouldn’t be a huge surprise—China has recapitalized banks after numerous periods of economic stress since 1998.
Historical Chinese Bank Recapitalizations:
Note: Excluding 2010, the figures cited above do not include IPOs.
Ultimately, this is one reason Chinese financial system reform is needed, or China will eventually experience great difficulty once their infrastructure productivity wanes. But that point likely isn’t in 2011, and with over $3 trillion in foreign currency reserves, China easily has the needed funds to execute a bailout right now, if desired.
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