China to audit local authorities and state enterprises over debt fears

It is suspected that Chinese state enterprises have used cheap loans to increase production. Photograph: Zhang Haiyan/Xinhua Press/Corbis

China's local authorities and state enterprises will come under scrutiny in the coming months after the government said it planned to audit their debts.

In a one sentence announcement on its website, the National Audit Office (NAO) said it planned to embark on a nationwide assessment of borrowing by public bodies, underlining fears that thousands of local councils and state-owned businesses in the world's second biggest economy have over-stretched themselves and are close to collapse.

The NAO said other audit projects would be frozen to complete the task, but failed to give a publication date.

Some analysts believe China's myriad local and state enterprises, many of which have borrowed heavily to invest in property, new factories and machinery over two decades of rapid economic expansion, have racked up debts of about $3tn (£2tn).

There is a suspicion that companies, especially in the heavy industrial sector and commercial property industry, have used cheap loans to increase production and pay higher wages rather than assess the long-term viability of their businesses.

Local governments, which are prevented from taking on debt directly, but have borrowed heavily through special-purpose vehicles, have frequently borrowed from companies in private arrangements at high cost, with the money often used in speculative real-estate projects.

Much of the lending is also believed to be directed to businesses that pay the highest bribes, undermining standard credit controls.

Last year a new communist party leadership took control in Beijing promising to crackdown on corruption and graft.

A slowdown in output over the past six months has been blamed on tackling corruption alongside a greater emphasis away from investment towards domestic consumption.

A local government buckling under the weight of its own debt is a troubling scenario for the leadership, and one that Deutsche Bank has said could potentially pose a systemic and macroeconomic risk to the country.

Standard Chartered, Fitch and Credit Suisse have estimated local government debt in China at the equivalent of anywhere between 15% and 36% of the country's output, or as much as $3tn based on World Bank GDP figures for 2012.

Chinese economists point out that the state has access to $3.5tn of foreign reserves built up in the boom times, which can be used to bail out failing enterprises or for investment in areas that ministers believe will create economic benefit.

Justin Lin, a former World Bank chief economist and senior adviser to the Chinese government, said at a conference in London last month that, while it was possible for Beijing to push through structural reforms too quickly and stymie growth, it was an unlikely outcome.

He predicted the economy would grow between 7.5% 8% for the next 20 years at least as domestic consumption on areas like health increase dramatically.

"China is a developing country and there is still so much scope for investment," he said.

Lin, a professor at Peking University, said China would cope with a rapidly ageing population and higher wage costs by turning to neighbouring countries, which act like subsidiaries with large pools of young labour.

"As long as it is made politically palatable in these countries for them to behave almost as client states, they can all benefit. Then there is the ability to increase the retirement age from the current 60 for men and 55 for women. Also the quality of the labour force can increase to offset the relative decline in the number of young people coming into it."

Vice-finance minister Zhu Guangyao said earlier this month that the government did not know precisely how much debt local governments had built up.

The audit office warned in a June report that debt levels among local governments are rising and the financial burdens and risks are not being properly managed. It put total debt of a sample of 36 local governments at 3.85tn yuan (£409bn) at the end of 2012.

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