Chinese state media and government officials have declared an initial victory in dealing with piles of local government debt, but analysts warn debt risks remain a big threat to the Chinese banking system and the world's second-largest economy.
In an attempt to quell investor jitters, China's state auditor in June laid the groundwork for a debt clean-up by releasing a review that said local governments had borrowed 10.7-trillion yuan ($1.67-trillion U.S.) by the end of 2010.
Chinese regulators have been reclassifying local government debts to ease banks' provisioning requirements for potential bad loans, the China Securities Journal reported on Monday, citing a source who said that more than 40 per cent of local government debt will fall due this year and next.
The "authoritative source" told the paper that about a third of loans granted to local government financing vehicles, or some 2.8-trillion yuan, were determined to be low-risk and would be booked as general corporate loans.
That designation would allow banks to put aside fewer provisions for these loans, a move that would relieve the pressure on banks to raise fresh capital.
China's Ministry of Finance also said that the local government debt risks are under control since Beijing has achieved initial success in dealing with the problem.
But Wang Haoyu, a senior analyst with First Capital Securities in Shenzhen, said the risks of local government debt remain.
"A third of the loans are reclassified as general company loans, which means safe, but how about the rest? There is no clear answer to that," Mr. Wang said.
He said Beijing is keeping up a tough stance in controlling the property market, and land revenues, a key source for income for local governments, would be limited in coming years.
"China's banking regulator is very tough as well. Banks were told not to extend existing credit or grant new loans to LGFVs that have no sufficient cash flows," Mr. Wang said.
Local government debt levels will peak in 2011 and 2012, with 4.6-trillion yuan of loans coming due, or 43 per cent of the total estimated loans that governments have borrowed to pay for infrastructure and investments.
"This source said that after several rounds of clean-ups by regulators, the risks that banks are carrying from local government financing vehicles have been much reduced," the paper stated.
China's pile of local debt has long been singled out by investors as a source of risk if slower growth in the world's second-biggest economy were to trigger a wave of loan defaults and hobble its banking system.
The auditor's estimate was challenged in July by Moody's, which said China had underestimated local government liabilities.
A statement published on the Ministry of Finance website on Monday asserted that China's local government debt issue is under control, claiming initial victory in containing risks in the local government financing vehicles.
China's finance ministry said the financing vehicles must honour their promises to repay bank loans, and local fiscal authorities should use fiscal funds to finance projects of "public goods."
Separately, the official Economic Daily reported in a front-page story on Monday that local government debt risks "should not be exaggerated."
Liu Shangxi, a researcher with the Ministry of Finance, was quoted as saying that Chinese local governments have sufficient fiscal resources in hand to pay back their debts.
"Apart from tax incomes, local governments have many other resources at their disposal such as land, assets at local state-owned enterprises and other non-operational assets," Mr. Liu said.
"Their assets were far more than their debts," he said.
Yang Zaiping, the executive vice-president of China Banking Association, said in an opinion piece in the Economic Daily that efforts by China's banking regulator to manage risks from LGFV (local government financing vehicles) loans have achieved some results during the past year.
Mr. Yang also stated that 2.8-trillion yuan worth of local government loans will be booked as general corporate loans.
Chinese banks are required to set up provisions of 300 per cent of possible losses from LGFV loans, or three times higher than the provision requirement for general company loans, the China Securities Journal reported.
It added that Beijing had encouraged banks to amend contracts, increase collateral demands and other steps to ease their exposure.
Planned municipal bond issuance could also help some local governments repay their bank loans, the paper said.