Moody's: China has adequate fiscal headroom to absorb local government contingent liabilities

Moody's Investors Service says that while higher levels of local government off-budget investment financing pose a challenge to the Government of China's (Aa3 stable) fiscal position, such debt levels are relatively moderate and can be absorbed over time by the sovereign's balance sheet.

"China's largest fiscal contingency is from local government finances," says Tom Byrne, a Moody's Senior Vice President for the Sovereign Risk Group.

"While local government financing operations raised the general government debt-to-GDP burden to 34% in 2014 from a low of 17% in 2005, China's debt trend appears to have stabilized," adds Byrne. "In addition, the government has an appreciable amount of fiscal space to accommodate such known risks."

Byrne also points out that China's fiscal profile is in the top bracket of Moody's global scoring range, based on the country's gross debt burden, total revenue and budgetary interest ratios.

Byrne was speaking at Moody's China Credit Risk Conference in Shanghai on 12 June 2015.

Byrne notes that the increase in direct general government debt has been driven by a surge in borrowing by local governments.

Byrne explains that because direct debt has grown beyond the capacity of some local governments to service such liabilities, the central government may need to provide additional fiscal resources to local governments to bolster their finances and debt-repayment capacity.

According to China's National Audit Office, local government direct budgetary debt and contingent off-budget debt as of 30 June 2013 totaled RMB17.9 trillion. Based on this figure, Moody's estimates that the large accumulation of local government contingent debt pushed China's total direct and indirect debt close to 50% of GDP in June 2013.

Despite the buildup in debt and in local government fiscal liabilities, the structure of China's government finances suggests ample room to manage known contingencies.

China's budget deficit is low and its gross financing needs are moderate. It also exhibits a very low dependency on external funding. In addition, the country's debt trajectory looks favorable; assuming the absence of any shock that results in substantial contingent liabilities being incurred.

Byrne further points out that China's nominal GDP growth strongly eclipses government debt interest costs.

Byrne says China's general government debt-to-GDP ratio will likely remain in the mid-to-high 30% range over the medium term, even with continued fiscalization of local government contingent liabilities.

Moreover, China's very large gross domestic savings rate -- which Moody's estimates stood at 49.9% of GDP in 2014, the highest of any big economy -- provides a deep and stable funding base for the government. It also offsets gross investment, which constituted a similarly large 47.9% of GDP.

In addition, the government's asset position is large. It could sell state-owned land, stakes in state-owned enterprises and other assets to raise capital if needed. Researchers from the Chinese Academy of Social Sciences estimate that Chinese government assets -- including land and equity in state-owned enterprises -- constitute in excess of 150% of GDP.

Byrne adds that while China's weak property market complicates local government budgetary financing, there are early signs of stabilization in the sector.

Moody's believes property sales will grow between 0% and 5% over the 12 months to June 2016, as the effects of supportive monetary and regulatory polices implemented since the second half of 2014 start to gather momentum.

As for the banking sector, Byrne says risks posed by the industry are remote, as long as macroeconomic stability prevails and leverage is contained in the state-owned enterprise sector.