China can’t afford to be smug about the euro zone’s woes. Although the nation’s total debt comes to no more than 44 per cent of GDP, China has some overextended regions of its own – Little Greeces. Hainan province, for example, has amassed debt close to 100 per cent GDP. The new policy of allowing local governments to issue their own bonds may make the problem worse.

High debt levels threaten to choke a fifth of Chinese cities, as a quarter of the $1.7 billion local government debt matures in 2011. According to the National Audit Office, as many as 78 Chinese cities have debt to GDP ratios of more than 100 per cent. The Southern Hainan province has the highest debt to GDP ratio of 93 per cent. Local government’s debt surged 19 percent in 2010, due to Beijing’s $4 trillion stimulus package. 

The central government is backing away. Beijing has recently launched a pilot program to allow local governments to issue debt, a sign that they will be expected to take care of their own debt burden. The Shanghai government’s auction of $568 million bonds this week will be followed by similar sales by three local governments in rich parts of China.

Less developed provinces may struggle to find willing buyers. Even if they can, the Greek experience shows that excess borrowing just stores up trouble. Over-indebted local governments should stop financing infrastructure projects off-budget. At least a third of local government expenditure, largely infrastructure, falls outside the budget and is paid through land sales or bank loans. Sharp falls in land auction proceeds, which make up 30 per cent of governments’ revenue, threaten to put more pressure on local government finances this year.

Local governments should sell shares in companies, or privatise bridges and highways to help reduce debt. The Shanghai municipal government has $218 billion assets in companies and infrastructure projects at the end of 2010, close to 87 per cent of its GDP. Even the Hainan local government has $23 billion assets, which equals to about 75 per cent of its GDP. China’s Little Greece should make best use of their strong balance sheet to avoid a European style liquidity shock.

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