A huge debt of RMB 2.1 trillion (330 billion USD) as well as serious funding problems—how will the Ministry of Railways handle it? Or more precisely, how will the behind-the-scenes decision-maker, China’s central government deal with this issue? We think there are three ways out of the debt mess.
Firstly, simply allow a deadly debt “crash”, i.e., default on MoR’s debt. The direct outcome of this decision would be a painful write-off on banks’ balance sheets, which hold the majority of MoR’s loans and bonds. However, we consider this as least likely. While there’s still room to discuss the possibility of Local Government Funding Vehicle (LGFV) default, MoR debt is more directly linked to central government credit. The Chinese government would never sacrifice the credit reputation it has always treasured over the MoR debt issue, let alone the danger of damaging the banking system it has laboriously built up.
Secondly, perform a rescue “surgery”. Actually, the Chinese government has already gained some experience in conducting such “surgery”. Dating back to post-1997, the Ministry of Finance issued RMB 270 billion special treasury bonds to replenish the capital of four big state-owned commercial banks, and their RMB 1.4 trillion non-performing loans (NPL) were separated to four asset management firms. Following that experience and several rounds of similar practices in 2000s, this time, over the MoR issue, we would expect either the Ministry of Finance to inject capital to MoR, or to separate the debt into another special asset management company. However, there’s the unavoidable risk of firing up public indignation over this practice. The public has been indirectly paying MoR’s debt by suffering a negative real interest rate; what if people suddenly realize they have to pay once the amount of total annual income to an killing entity?
Thirdly, ”extend and pretend”. This is what the government has been doing. Without strong political support, MoR would have easily gone bankrupt. Just imagine how much interest payment on RMB 2.1 trillion debt MoR would have to undertake, should interest rate benchmark be raised, or MoR were to be downgraded from AAA by Dagong, the Chinese credit-rating agency. There are a few more “bullets” the Chinese government could use in future. For example, it could demand National Development and Reform Committee (NDRC) to lift the 40% net asset limit for outstanding bonds, facilitating MoR to roll over its long-term bonds. Besides, the government could also impose regulations to let local railway bureaus to finance by themselves, thus shifting the problem to local government.
In all, we argue that, China has found itself in a debt quagmire together with the US and Europe, though trapped for different reasons. We saw Uncle Sam’s right arm pulling down the left arm; Europe is still fighting with herself with mud and blood all over. We shall see how China will deal with MoR debt issue as it tries to stay out of the swamp.
Lin Qiaowei
Central Banking Seminar
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