Hidden from sight, debt creeps up on China

By Simon Rabinovitch - Analysis

BEIJING (Reuters) - On the surface, China presents a fiscal study in contrast with the United States, keeping a remarkably low ceiling on debt even as it spends its way out of the financial crisis.

But hidden liabilities mean China's books are uglier -- potentially much uglier -- than at first sight.

Thanks to successive years of fast economic growth and even faster government revenue growth, the official debt-to-GDP ratio was 17.7 percent at the end of last year, far lower than almost any other major economy.

The trouble is that excludes local government borrowing, the current surge in loans backstopped by Beijing and bad assets cleared from the banking system but still floating about.

When all are thrown into the pot, analysts estimate that China's debt may be closer to 60 percent of GDP, putting it in virtually the same league as the United States, which was at 70 percent at the end of 2008 before it launched its massive economic stimulus program.

To be sure, Washington is now set on a path of exploding debt that Beijing will largely avoid. The United States budgeted for a federal deficit of 12.9 percent of GDP this year, whereas China is aiming for just 2.9 percent.

But China's finances are deteriorating more quickly than the government expected, fuelling a rise in the stock of both explicit and disguised debt that will constrict its wriggle room.

"It is serious because, one, much of it is hidden and, two, local governments are currently doubling down on their bets," said Stephen Green, economist at Standard Chartered Bank in Shanghai. "As with all fiscal deficits, it limits space for further stimulus."

This is probably a moot point, for now. With China's economy back on track and private-sector investment kicking in, few think Beijing will need to ramp up spending beyond its existing 4 trillion yuan ($585 billion), two-year stimulus plan. But the narrowing of options still discomfits Chinese leaders.

"Our fiscal work is very grim," Chinese Premier Wen Jiabao told officials last week.

ERODING FINANCES

Government revenues declined 2.4 percent in the first half compared to a year earlier, well shy of the official goal of an 8 percent rise. Expenditures were ahead of target and set to surge in the second half on the back of infrastructure projects.

Tax intakes are, of course, closely tied to economic activity, so China's upturn should deliver cash to government coffers. But improvement in June came mainly from land sales, a one-off revenue source that masks the difficult road ahead.

"Even when we are already factoring in relatively optimistic revenue growth due to the economic recovery, the deficit is quite sticky at around 5 percent per year for the next three years," said Isaac Meng, economist at BNP Paribas in Beijing.

But the real worry is the thickening morass of indirect debt.