Private push can help tackle mounting concerns over local government debt across the country

I hadn't mailed any letter since I graduated from university more than 10 years ago. But one thing was always in my mind. It was China Post that sent all the letters when I was a child.

Last week, I had to post a letter as part of some urgent legal documents to Hong Kong. So I called a China Post branch to ask how much it cost and how long it would take for the letter to reach Hong Kong.

"Three weeks and 30 yuan," the China Post receptionist replied. The price didn't bother me, but the three weeks did. I asked: "Can I pay more to ensure a quicker delivery?"

"Yes, but the fastest delivery is still one week," was the answer. Disappointed, I said "thank you" and hung up the phone.

Through the recommendation of a friend, I finally opted to send the document through a private courier company. It cost 30 yuan and took three days.

This is typical of how government services can be far less efficient and more expensive than private businesses.

This is also food for thought for the government, which is struggling to deal with mounting local debts, on the way to proceed.

Late last month, the National Audit Office announced that it would launch a nationwide audit of government debt. The news spooked the nation's capital markets, which expected a huge debt crisis. The benchmark Shanghai Composite Index dived more than 4 percent the day after the news came out.

While it is still unclear whether the mounting government liabilities will evolve into a crisis, market observers agree that local debts are indeed a major problem, if not a tumor as some have dubbed them, for the Chinese economy.

The government's decision to assess local debts therefore clearly reflects its concerns on the issue. Recent developments have also added to the concerns. An audit of 36 local governments, whose results were announced in June, showed that 17 cities' government assets were less than debts they owed by the end of last year. Given the fact that these 36 governments were from affluent regions such as Shanghai, Tianjin, Jiangsu, Guangdong and Shandong, the overall picture of the country could be even worse.

Recent mass protests in Shenmu, a coal-rich county in Shaanxi province, after a flurry of corporate bankruptcies left private lenders high and dry, also reflected the severity of the leverage rate in some parts of China.

In Ordos, the Inner Mongolia city that once boasted of the highest per capita GDP in China, the government is estimated to have a debt that equals six years' fiscal income. Its capital chain has broken down after real estate and coal industries nosedived.

Though this is an extreme example of local government becoming debt-ridden, the fact is that Ordos may not be alone. Local governments' ability to repay debts is apparently diminishing, given slower growth of land revenue, which accounted for more than 70 percent of their revenues.

On the international front, the bankruptcy of Detroit tells policymakers worldwide that a government must spend within its means.

Chinese cities definitely need to keep an eye on their debt ratio.

But what is tricky is that no one can estimate the exact size of local debt in China. The latest official version was that local governments at and above county levels owed 10.7 trillion yuan by the end of 2010. This figure is more than two years old and can by no means reflect the ever-changing debt market. Moody's put it at 12.85 trillion yuan. Barclays Capital said it was 20 trillion yuan by the end of last year, while Morgan Stanley estimated it was a bit more than 14 trillion yuan. The most alarming guess put the figure at 40 trillion yuan. Just to give these figures more sense, China's GDP last year was 52 trillion yuan and the national fiscal income that year was 11.7 trillion yuan.

Clearly, top policymakers are addressing this issue. The main concern obviously is to figure out how big the debts are and how well the government can deal with them. That also explains why the National Audit Office said it would check the debt books across the nation.

But before we ask why governments borrow so much money, we also need to understand why we should need the government to invest in the first place.

My experience with China Post may not be universal. But it is representative of how the government can be less efficient in investment. According to various surveys, private investors' profit-to-cost ratio can be 2 to 5 percentage points higher than their state-owned counterparts in fully competitive sectors, such as retail, which are not twisted by unfair treatment like government monopolies and procurement.

But that is not to say the government should not invest. On the contrary, it is the government's duty to invest in areas that do not yield immediate profits or that do not make money but are vital for social and economic development. Examples include railways in poor regions and social welfare networks.

The government should also become an investor in key areas and industries when private businesses are too small, too weak or reluctant to invest. Aircraft are such a case in China.

In addition, it must hold some stake in strategic sectors, such as telecoms, to ensure national security. Of course, it can also invest reserves such as the sovereign wealth fund and the social security fund to maintain value for the good of taxpayers.

Apart from those, there is no point for a government to act as an investor. Instead, it should let private lenders invest.

But in China, the government shoulders many of the responsibilities that the businesses should do, which is the legacy of a planned economy.

The government has its own penchant for investment and deems itself the major economic mover instead of a service provider and regulator of businesses.

The GDP-above-all mentality aggravates the spending spree, with local governments rushing to borrow money from all channels such as commercial banks, trust funds, state-owned companies and even individuals to boost GDP figures. Highly polluted and resources-consuming projects such as steel and chemicals, which can generate quick and sizeable GDP, are their favorites.

Assuming that the central government will bail them out in case of insolvency, because what they invest in and what they borrow are essentially state assets, local government officials are not shy or cautious in issuing debts or applying for loans.

But since government investment is often less sufficient, as reflected in my China Post case, the spending spree has led to a combination of problems such as mounting debts, a waste and a mismatch of capital and resources, unbalanced development between public and private sectors, heavy pollution and possibly rising corruption.

That said, to root out the local debt risk, top policymakers should act in three ways.

First, the GDP-above-all mentality must be thrown into the dustbin so that local governments will not invest for the sake of investing. In this sense, the central government should set an example. Indeed, it could ask the top legislature to reduce this year's GDP growth goal from 7.5 percent to 7 percent to reinforce the determination to improve the economic quality instead of growth.

Second, private and individual investors should be given wider market access so that the government can focus on its role of serving society and businesses instead of investing as a commercial entity. Premier Li Keqiang's recent announcement allowing private investors to invest in railways was in the right direction. But more needs to be done in reforming the financial system, such as allowing private banks to be set up without limits. At the same time, government spending must be curbed so that capital can flow to non-public sectors and personal wealth.

Third, the central government should allow small cases of default of debts and ask local governments to repay as much as possible by tightening their belts, so long as this will not cause a systematic meltdown. As Mark Grant wrote in his book Out of the Box and onto the Wall Street, experience is the best teacher. It is good to let the painful experience of default teach local leaders a lesson: You must be cautious with every penny you borrow.

The author is a Shanghai-based financial analyst. The views do not necessarily reflect those of China Daily.