China today is much more than South America’s second largest customer. China is the largest source of soft loans to these governments. With growth slowing, skyrocketing municipal debt will soon lead to a fiscal crisis.
On December 30th 2013, a long awaited report published by China’s National Audit Office confirmed the fears of many – municipal debt levels had soared, to $3 trillion, or 30 percent of GDP. For decades, China’s communist party has rewarded municipal leaders who delivered growth and job creation and allowed state-run banks to lend at artificially low rates. The municipal spending spree grew to feverish levels in 2008 when the Central government unveiled the world’s largest fiscal stimulus plan to mitigate the collapse of Chinese exports to the U.S. and Europe. There are dozens of mid-size cities in China with roads, subways and public housing built decades ahead of their time, today underutilized and costly to maintain.
With growth slowing in China, skyrocketing municipal debt will soon lead to a municipal fiscal crisis as loans come due and the true costs of corruption are realized. The national government will almost certainly step in before any municipality defaults for fear of triggering a run on Chinese debt or any of the overexposed national banks, but doing so will cost more trillions. In the meantime, Beijing will continue its policy or ratcheting up the reserve ratio, forcing banks to write off or recall the most delinquent of its opaquely recorded loans.
A few brave independent analysts in China began shedding light on China’s growing public debt and shadow bank economy in Q1, 2013. Their skepticism has piqued the interest of international traders and investors, including George Soros, the most notorious currency raider of them all, who once earned a billion dollars shorting the English pound.
Some startling figures are being unmasked by Chinese analysts, many of which are difficult to corroborate but unrefuted thus far by Beijing officials. Of the 19 trillion yuan in municipal debt accumulated over the last five years, more than 500 million has been flagged by the auditors’ report as questionable – many believe the corruption levels are closer to 10 percent, not 2.5 percent of spending. Worrying to Chinese leaders hoping to keep a lid on this crisis is the fact that the Chinese affluent were able to send an estimated $3.97 trillion out of the country between 2000 and 2011.
All told, Chinese government debt amounts to 53 percent of GDP. But Chinese corporate debt is twice that level, much of it lent to inefficient state-owned enterprises. China’s national government can cover its public debt obligations, but can it stave off an internationally driven shorting of Chinese bonds and equities coupled with the exit of national capital through the limited channels available? If forced to take bold measures, Beijing’s defensive actions could curb growth dramatically, thereby impacting demand for Latin American exports of all kinds, but particularly commodities. A credit crunch in China would raise the cost of capital around the globe, exposing another Latin American vulnerability – foreign debt.
China today is much more than South America’s second largest customer. China is the largest source of soft loans to South American governments, often underwritten by future oil export contracts. Chinese SOEs have become some of the largest foreign direct investors in the region, particularly in natural resources, but also in infrastructure – a long-term strategy to guarantee Chinese companies access to cheap input commodities.
The China, Inc. model of foreign investment is often lauded for its long-term strategic mindset, but it is also vulnerable to any fiscal pullback that could result from a debt crisis back home. China’s particular brand of commercially focused foreign policy, though vital to the long-term growth of the Chinese economy, is a low political priority in a communist government that is hypersensitive to domestic instability. China’s runaway municipal debt will force Chinese leaders to focus on sustaining domestic growth and will likely cannibalize the considerable resources that have recently been dedicated to penetrating Latin American markets. An old regional adage now has a new twist: “When Beijing sneezes, Latin America catches a cold.”
John Price is the managing director of Americas Market Intelligence
and a 20-year veteran of Latin American competitive intelligence
and strategy consulting. firstname.lastname@example.org
About the Author: John Price is the managing director of Americas Market Intelligence and a 20-year veteran of Latin American competitive intelligence and strategy consulting. email@example.com.