• Bloomberg


China will start a nationwide audit of government debt this week as the new Communist Party leadership investigates the threats to growth and the financial system from a record credit boom.

The State Council, under Premier Li Keqiang, ordered the review, the National Audit Office said in a statement Sunday. The office suspended other projects for this “urgent” work requested on Friday and will send staff to provinces and cities this week, People’s Daily reported, citing unidentified sources.

The first full audit in more than two years underscores the International Monetary Fund’s concern about risks to the economy from borrowing by local governments and an expansion of nontraditional sources of credit. The new leadership oversaw a showdown with state-owned lenders last month as the People’s Bank of China engineered a cash squeeze to pressure banks to better manage their operations.

“Local-government debt has become a focus in recent years and is a source of concern about China’s growth,” Ding Shuang, senior China economist at Citigroup Inc. in Hong Kong, said. “The new leadership is trying to give a clear answer.”

Last week, China announced what Bank of America Corp. called a “small stimulus,” expanded a crackdown on wasteful government spending and ordered cuts in manufacturing overcapacity, as new leaders grapple with a slowing economy and public concerns ranging from house prices to corruption. Efforts to sustain growth include small-company tax breaks and speeding up railway construction, while frugality measures include a five-year ban on building government offices.

The first audit of local-government debt found liabilities of 10.7 trillion yuan ($1.75 trillion) at the end of 2010, the National Audit Office said in June 2011.

The audit’s urgency may be because “confidence in the Chinese economy from all sides has weakened recently,” Ding said.

Ding estimated China has at least 12 trillion yuan of local-government debt. The review may pave the way for future fiscal reforms, including changes to rules on local governments’ roles and responsibilities, Ding said.

Separately, the central government has decided to cap the ratio of the fiscal deficit to gross domestic product at 3 percent in a bid to avert a downgrade of China’s credit-rating by international rating companies, China Business News reported Monday, citing an unidentified source.

The government must be on “high alert” to the dangers of rising borrowing, Vice Finance Minister Zhu Guangyao warned July 5, after central bank Gov. Zhou Xiaochuan said in March that about 20 percent of local government debt is risky.

Local-government financing vehicles (LGFVs) need to repay a record amount of debt this year, prompting Moody’s Investors Service to warn that Premier Li may set an example by allowing China’s first onshore bond default.

Regional governments set up more than 10,000 LGFVs to fund the construction of roads, sewage plants and subways after they were barred from directly issuing bonds under a 1994 budget law. A 4 trillion yuan stimulus plan during the 2008-09 financial crisis swelled loans to companies, which they have been rolling over or refinancing with new note sales.

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