Alexander Hamilton, as the first U.S. Treasury Secretary, honored state-government liabilities, believing the revolutionary war debt was the price the newly formed republic paid for its liberty. His philosophy has a following today in China, as it grapples with the massive debt its provinces have racked up in the pursuit of economic prosperity.
The Ministry of Finance under Lou Jiwei has allowed local governments to swap 1 trillion yuan ($160 billion) of high-cost debt into low-yielding local government bonds -- a move that’ll help save up to 50 billion yuan in interest payments each year. What about the rest?
China’s local-government borrowings swelled to 17.9 trillion yuan as of June 2013, National Audit Office data showed. The liabilities may have now reached 25 trillion yuan, bigger than the size of the German economy, according to estimates from Mizuho Securities Asia. Other estimates have placed it a bit lower.
Gossip circulating among journalists and academics on WeChat cited the Hamilton precedent in mooting one solution: a version of quantitative easing with the People’s Bank of China providing 10 trillion yuan to financial institutions, which would then buy low-yielding municipal bonds issued by local governments to swap existing obligations. Chinese Vice Finance Minister Zhu Guangyao quickly discounted the speculation as “untrue words.”
The following chart shows the central government does have options should it wish to bail out its provincial counterparts:
The biggest obstacle to a Hamiltonesque solution may be the central government's desire to avoid the moral hazard such a bailout would represent.
Another impediment to any such plan is PBOC Governor Zhou Xiaochuan's conservatism.
"The PBOC is the Bundesbank of EM,"' said Stephen Jen, co-founder of SLJ Macro Partners in London and a former International Monetary Fund economist. "It is conservative and does not have the mindset of the Fed: print money to stimulate aggregate demand.''
In the meantime, the 1 trillion yuan debt swap buys Finance Minister Lou time to mull other fixes for the debt hangover.