China's local government-backed financing vehicles had total debt of 14 trillion yuan ($2.16 trillion) at the end of last year, higher than market estimations, but fears over the effect that defaults could have been exaggerated, observers said on Thursday.
"Loans to local government financing vehicles (LGFVs) accounted for less than 30 percent of total outstanding loans at the end of 2010," the People's Bank of China said in a financial review report published Wednesday night. Many LGFVs are city-level investment companies that invest for local governments.
Based on that figure, LGFV debt would amount to a maximum of 14 trillion yuan out of total outstanding loans of 47.92 trillion yuan at the end of last year.
That would be equivalent to 35 percent of China's 2010 GDP and higher than previous estimations of about 10 trillion yuan. Debt has risen since China started its massive economic stimulus package in 2008 and embarked on a lending spree over the last two years.
Local governments, barred from selling bonds or borrowing directly from banks, had set up more than 10,000 financing vehicles by the end of 2010 to raise funds, mostly for infrastructure, the central bank said.
LGFVs are backed by local government revenues, which mainly come from land sales.
But tightened monetary policy, efforts to rein in soaring housing prices and the limited land resources have prompted fears that some LGFVs will not be able to repay their loans.
More than half OF the LGFVs had borrowed long-term loans lasting five years, which were mainly invested in low- and slow-return infrastructure projects, so the credit default risk may be substantial, Bian Xiaoyu, a banking sector analyst with CIC industry research center, said.
Local media reported that policymakers might allow local governments to issue bonds as a way of clearing some of the 2-3 trillion yuan debts that LGFVs may fail to repay.
However, "LGFV defaults could cause liquidity problems for banks but won't actually bankrupt them," Liu Ligang, head of China economics with ANZ Banking Group, said.
LGFV non-performing loans (NPLs) could push up the Chinese banking sector's overall NPL ratio to 6-8 percent from its current level of less than 2 percent, but wouldn't lead to risks of system failure, Liu said.
Local governments can also sell equities in local assets including city commercial banks and State-owned enterprises to private companies or individual investors in exchange for cash to pay back loans, he said.