Move 'aims to reveal mounting risks and pave way for reform of finance system'

The National Audit Office declared on Sunday that it will start a nationwide assessment of local government liabilities, which will address concerns about rising debt from overambitious development projects.

The announcement was made following Chinese media reports that the State Council has made the audit campaign one of its "urgent" tasks, and that all government auditors are being given crash training so they can start the audit as early as next week.

Their work is expected to update China's local government debt figures, which stood at 10.7 trillion yuan ($1.75 trillion) by the end of 2010.

By comparison, China's GDP was close to 52 trillion yuan in 2012.

But an estimate by the International Monetary Fund last month put China's total government liability, including government-led infrastructure development projects, in excess of 45 percent of the country's GDP.

Experts said the new audit aims to reveal mounting risks from rising local government debt, which has sparked fears of a hard landing for the economy amid a continuous slowdown.

In the meantime, the effort will pave the way for a possible overhaul of the public finance system to build a healthier and more responsible financial administration, they said.

In the short term, the move will provide decision-makers with clear options, said Zhao Quanhou, head of financial research at the Fiscal Science Research Center affiliated with the Ministry of Finance.

If the results turn out to be good, he said, new policies could loosen local government financing, as the economy still yearns for capital to restore growth.

"But given local government debt conditions in recent years, the results are unlikely to be promising," he said.

In a June report, a survey of 36 provinces and cities showed debt levels expanded 13 percent over the past two years.

Du Xiangqian, a government auditing researcher, said the 2011 audit work was completed and made public within five months, and this year's project may require about the same time.

But this year's task will not be easy, as the scope of the audit might be broadened to include village governments.

Du said local conditions were really "complicated".

"Some village heads borrowed in their own names for public spending because they're more reliable than the village council," he said, adding that local government financing channels are quite diverse.

Jiang Chao, chief analyst of the debt market with Haitong Securities, estimated that the amount of local government debt was around 15 trillion yuan — 9.5 trillion yuan in loans, 3 trillion yuan in trust funds, 2 trillion yuan in city investment bonds and 0.65 trillion yuan in local government bonds.

He warned that infrastructure investment might stall if financing via trust funds is halted, as the investment is mainly supported by off-balance sheet borrowings.

Zhang Houqi, vice-president of China Asset Management, said on his micro blog that the audit will unveil many irregularities in local government account books.

"It is definitely bad news for the stock market and may even turn into a significant event for the economy this year," Zhang wrote.

Zhao from the Fiscal Science Research Center said that although local governments will not go bankrupt, as Detroit did in the US, local officials will be removed for fiscal failures. But Zhao said the NAO's move was one of a series of measures to digest China's debt risks.

On July 18, the Finance Ministry issued a notice asking each province to submit an action plan to tighten budget execution and control cash management by the end of the month, reflecting the government's commitment to quickly improve fiscal practices at the local level.

"The central government has been proceeding in measured steps as it seeks to balance its twin objectives of granting local governments more autonomy with respect to their financing needs and of maintaining strong controls to ensure that debt levels are affordable," said Moody's Investors Service in a report.

Ultimately, a local government bond market would help improve monitoring and regulation of local governments' indebtedness, improve accountability for their investments and borrowing decisions, and discourage them from engaging in irregular financing activities, Moody's said.