Local Government Debt Shadows China

Emerging Markets Investor: News

By Gordon Platt

Julian Thompson, portfolio manager at Threadneedle Emerging Markets Equity Fund, says he expects China’s economic growth to slow and sees much more opportunity in other parts of the world. Much of China’s massive investment in recent years has been funded through local government debt, Thompson says. “If returns on this investment capital fall short of expectations, the debt-servicing ability of these governments may become problematic,” he explains.

Wages in China need to continue to grow to make domestic consumption a bigger part of gross domestic product, Thompson says. This will put upward pressure on inflation and force the government to tighten monetary policy, he says. The financial sector in China needs capital to continue growing, he adds, which may also hinder the country’s economic expansion. The sustainability of the economic cycle looks to be more favorable in parts of Latin America and EMEA (Europe, the Middle East and Africa) than in China, he believes.

More than one-fifth of China’s local government loans could turn sour, according to a report by HSBC. “It’s high time for China to act decisively to restructure local government debts,” the report says. HSBC economists say the most feasible option is a bonds-for-loans swap scheme.

Local governments in China form an integrated part of the state government system, which means that, ultimately, local government debt is a central government liability, HSBC says.