MCLC: rotten regions

Wed Jul 11 10:28:49 EDT 2012

MCLC LIST
From: kirk (denton.2 at osu.edu)
Subject: rotten regions
***********************************************************

Source: Asia Times (7/7/12):
http://www.atimes.com/atimes/China/NG07Ad01.html

China takes aim at rotten regions
By Peter Lee 

It is safe to say that China has a local governance problem. How the
central government deals with this problem - or fails to deal with it -
may be decisive in determining how ugly political life can get in the
People's Republic of China (PRC) over the next few years.

The latest local disturbance, in the mountain municipality of Shifang in
southwestern Sichuan province, has apparently given the government and
party considerable food for thought.

On July 2, the call went out over social media for the city's inhabitants
to "take a stroll", ie engage in an unapproved and unorganized protest
march to oppose a mammoth molybdenum and copper project that had just
begun construction in the economic development zone.

Perhaps 10,000 people showed up to chant slogans and sign anti-project
petitions. 

Depending on who is telling the story, either a few bad eggs egged on the
crowd to invade government and party offices, or the cops rioted when
confronted with a low level of defiance.

What is clear is that police and armed police reinforcements were rushed
in from adjoining municipalities and a convoy of 10 vanloads of riot
police rolled in from Chengdu, provincial capital of Sichuan. Tear gas and
flash grenades were fired, baton charges were made, and a lot of people
got hurt. 

The government said 13 people were taken by ambulance to hospitals for
treatment; the other side said hundreds were hurt and perhaps three people
died. Judging from pictures taken at the scene and in hospitals of victims
who were either truncheoned or struck by canister munitions, police
violence was disproportionate, reckless and indiscriminate, and reached a
level of intensity that would have been sufficient to cause fatalities.

The interesting element of the bloody melee was the level of discussion
concerning the "Shifang Affair" that was permitted in national
conventional and social media.

A journalist commented on Weibo:

A widely reposted photograph on Weibo depicted incensed citizens trampling
on the signage of the Shifang municipal party committee. Additional photo
albums provide graphic illustrations of the injuries suffered by Shifang
citizens. 

In addition, postings on Weibo gave vent to the kinds of sentiments that
the Chinese censorship apparatus is theoretically in the business of
suppressing, and also passed on information on new demonstrations:

And, as the above post reveals, local government capitulation on the issue
of the project was nearly instantaneous and complete.

First, the local government announced the project would only proceed on a
provisional basis, subject to careful monitoring and review. Then, the
head of the municipal party committee simply announced that "the project
construction would not continue," and apologized for shortcomings in
propaganda work that caused the project not to meet with the approval of
many local citizens. [1]

The molybdenum/copper project is no small potato. A key project of
Sichuan's Five-Year Plan, its total planned investment is over US$1
billion. One must assume that canceling such a project is above the pay
grade of a municipal party chief, and the party center told him to pull
the plug - with astounding speed.

There is a lot of chessboard - Sichuan business interests suddenly
unpopular in Beijing? Falling copper prices? That cannot be seen, at least
for now. But certainly, the center is showing little if any appetite for
cracking down on the protesters - whose actions were given the favorable
classification of a "mass incident" - at least for now and is loath to
provide even a scintilla of support to the local government.

Media reportage and commentary is shoehorning the protest and the rapid,
favorable response into the category of NIMBY ("Not In My Back Yard")
environmentalism, drawing parallels with mass protests and Dalian
Municipality's rapid capitulation on the closing of a paraxylene plant
last year. Indeed, the Shifang protests took fears of environmental
degradation as their theme, specifically fear of heavy metal contamination
from the smelting operation.

However, the situation in Shifang - a mass protest with students at its
core in a remote town against a plant that 1) hadn't been built and 2)
claimed to include an investment of 1 billion yuan (US$157 million) in
sophisticated environmental protection gear - seems different from Dalian
- an episode of mass panic that morphed into a campaign against an
existing, aging menace behind a crumbling seawall that threatened tens of
thousands of residents of a major city with exposure to carcinogens.

It might simply be that the people of Shifang, even before the carnival of
brutality on July 1, don't particularly like or trust their government.
And that's a problem because, if local government had the opportunity to
put its best foot forward, it was in Shifang.

The municipality was devastated in the Great Wenchuan Earthquake of 2008,
and it reportedly suffered thousands of fatalities and hundreds of
millions of yuan in losses. By its own estimation, the Chinese government
poured one trillion yuan into the wider region including Shifang, and
Premier Wen Jiabao visited the area nine times to demonstrate the center's
solicitude for the victims.

The city of Shifang is sometimes referred to as "New Shifang" in
recognition of the massive rebuilding that took place. One might think
that this reconstruction effort, paired with the construction of an
immense tax and employment-generating industrial enterprise, would endow
the local government with a measure of prestige, revenue and political
security unique in China's countryside.

Therefore, the center is likely to regard Shifang's descent into rage and
bloodshed as a rebuke to its immense efforts - a rebuke that it will
quickly attribute to the failings of the local government.

For the Wenchuan disaster zone, the failings of various local governments
are already a matter of national and international record.

After a brief honeymoon period celebrating the massive Chinese response,
attention turned to the disproportionate number of child victims, due to
shoddy and corrupt construction of schoolhouses. Noted chronicler of
Sichuan's lower classes (and now self-exiled author) Liao Yiwu documented
the heavy-handed efforts of local governments evading culpability for the
schoolhouses, bullying parents who were looking for compensation, and
sucking up reconstruction funds for their own benefit.

Therefore, it is an interesting and important item of inquiry for the
central government to ascertain how much of the Shifang Incident can be
attributed to environmentalism-tinged outrage and the protesters' desire
to preserve "New Shifang" (a pastoral paradise of crystalline mineral
water and fine cigar production, according to its citizens), and how much
of it simply reflected rage at the local government.

The incident will no doubt add to an ongoing debate within the Chinese
government as to how to define and manage the growing fiscal and political
burden imposed on the center by troublesome local governments.

With the tax reforms of 2003, local governments were to a significant
extent cut loose to find their own way. The yawning gap between tax
revenues and the sum of the local governments' obligations and ambitions
was filled with special impositions, land grabs, and real estate deals.
The center's contribution, when it came, was not necessarily a healthy
one. 

In response to the world financial crisis, the bank lending spigot was
turned open in 2008, allowing local governments to borrow on behalf of
hundreds of billions of dollars' worth of casually approved projects of
dubious worth. At the same time, as public dissatisfaction with the
government festered, the center provided provinces and municipalities with
"wei an" or "stability maintenance" funds that, particularly for poorer
districts, became a vital source of income.

Now, thanks in large part to the tottering eurozone, the world economy is
faltering again. The Chinese government is not going to go down the
mega-stimulus road again. The tsunami of money that flooded the country in
2008 has yet to recede, or be absorbed into worthwhile, revenue-generating
projects. The economy has to be allowed to slow down, while managing the
attendant economic, social, and political pain.

Local governments are at the forefront of this issue because they serve as
the primary interface between the regime and the disgruntled citizenry.
Also, the immense bank debt incurred by the local governments (and the
prospect of looming default as the loans begin to come due) cast a shadow
over central government's attempts to use its financial and fiscal tools
to manage the economy through a particularly tricky and dangerous patch in
a more targeted, scientific, and efficient manner.

The center got an idea of the magnitude of the problem by sending out an
audit team in mid-2010. It came back with some very big numbers. It turned
out that so-called local government financing vehicles or LGFVs had
accumulated debts of 10.7 trillion yuan by the end of 2010. [2]

Seventy-nine percent of this debt was in the hands of banks (less than 10%
had been raised as bonds) and was therefore looming on bank balance
sheets, 40% of the loans come due in 2015.

Moody's provided additional texture to the picture by declaring that
another $540 billion should be added to the figure to compensate for lies
probably made to auditors, and darkly warned that "Unless China comes up
with a 'clear master plan' to clear up the huge stockpile of local debts,
the credit outlook for Chinese banks could turn negative." [3]

An investigative report by Chen Zhilong of Xinhua Daily (a major
provincial paper in Jiangsu province, not the national news agency)
revealed that these loans were overwhelmingly collateralized by land held
by government land offices at the provincial, county, and municipal level,
and a lot of the collateral was simply terrible.

There were cases in which the LGFVs offered as collateral land had
hospitals, schools, and parks already on it, rendering foreclosure
impossible. There were cases when highway medians were offered as
collateral. Then there were the cases of "a wife with many husbands",
meaning that the same piece of land was offered as collateral for multiple
loans. Sometimes in place of the original deed, there was a copy;
sometimes there was nothing. And of course there were cases of inflated
valuations.

Chen points out that the Chinese bubble - and the reckless lending that
continued to inflate it - resembled the Western experience in that it was
fueled by the assumption that real estate values would continue to rise
and never fall. An important difference, at least for integrity of the
financial system, was that China has not yet fully discovered the
wonderful world of derivatives, or the leveraging of catastrophe that
inspired financial engineering can bring about. [4]

The downside, however, is that China's big banks still have no reliable
market channel to take the risk off their books, leaving them with a big
and dangerous gap between their short-term deposit obligations and their
long-term real estate assets, which now threaten to deliver writedowns
instead of appreciation.

The central government made an important decision on June 26 with regard
to the tottering mountain of local debt. It decided not to kick the can
down the road by letting feckless local governments go into the bond
market to refinance their debt. Despite conducting trial programs in local
issue in places like Zhejiang and Shenzhen, the government decided that
local governments could only issue bonds with the approval of the State
Council. 

Chen praises this decision for showing the central government's
determination to confront the local debt problem, and break the dangerous
real-estate based links between local government budgeting and the
financial system. 

As to how to handle the problem, apparently the center would not like to
see the problem get any bigger - hence the limit on the ability of the
local governments to go into greater debt directly - but also hopes it
doesn't get stuck with the entire bill for the cleanup.

Therefore, even as the ban on local issuance of bonds went into effect,
the Chinese government was doing what it could to refinance the local
governments' debt and get it off the books of the banks.

Although local governments cannot sell bonds without central government
approval-and imply that the debt is sovereign or close to it, the central
government has encouraged so-called "regional finance companies" to tap
the debt markets as commercial entities.

Per Bloomberg:

Unfortunately, as economic growth weakens, the central government has been
compelled to ease bank lending restrictions in order to keep the soft
landing from turning into a crash.

Political imperatives also tie the government's hands. On July 2,
Bloomberg reported that the central government had sold 21 billion yuan
worth of bonds on behalf of Qingdao, Guangxi, Hainan, Chongqing, Shaanxi,
Xinjiang and Gansu the previous Friday.

However, this was not a refinance. This is part of a 250 billion yuan
program under which the central government is borrowing the money so that
the locals will be compelled to do what the center has promised they will
do but they have no interest in doing: building low-income housing for
residents priced out of the market by the real estate bubble. It looks and
smells more like new national sovereign debt than anything else.

With the economy slowing and the equity markets stalled and skeptical, the
genuine face of local government debt workout will apparently be the
regional finance companies. Regional entities that can tell the bond
market a plausible story will be expected to refinance by peddling their
paper to discerning investors on behalf of their local government masters.
The central government can only hope that the institutions with a yen for
this rather dubious and not demonstrably liquid product don't turn out to
be the very same banks that the center is trying to wean off local
government debt. 

Meanwhile, the banking system will make funds available to local borrowers
in order to keep them and the national economy afloat but warily and with
a new-found rigor in examining asset values and cash flows.

Local governments that don't have a story worth telling the bond market or
the banks in an atmosphere of shaky real estate values are, I believe,
going to experience some tough love at the hands of the central
government. Localities that encounter political difficulties as a result
of worsening economic conditions will find a central government that will
not reflexively protect local cadres from the consequences of their
mistakes and misfortunes.

When the 10.7 trillion yuan figure first surfaced in the summer of 2011 -
and the real estate market wasn't looking as shaky - a Chinese economist
blithely recommended that local governments sell assets to cover their
debts, instead of looking for a bailout. [6]

Local cadres, on the other hand, will do anything they can to try to prop
up their finances, as Caijing reported on June 27:

<New policies to ease home restrictions in a local Chinese province have
been halted by the central government, even before they are actually
carried out ... 

21st Century Business Herald reported that reports that the central Henan
Province had ordered local banks to give up to 30% discount in loan rate
for first-home buyers are completely "misinformation". ...

According to Chinese news outlets, the new policies were written into a
government document to prop up the property sector, which was issued
jointly by six departments of local government, and had been distributed
to local authorities about two weeks ago. ...

The cat-and-mouse game is the latest in a series of local government
impulse to ease property restrictions because they are too dependent on
property sales for their revenue. [7]>

As the example of Shifang demonstrates, as discontent and unrest swirl
throughout China, the central government - at least the liberal wing - may
try to accumulate political capital by siding with aggrieved citizens
against local government abuse. Better to hang separately than hang
together, in other words.

Andy Xie, the ex-Morgan Stanley honcho who leads the reformist charge in
the pages of Caixin, also pointed out the dangers of lining up on the side
of the local governments and giving priority to solving their fiscal woes,
perhaps by throwing money at consumers to buy real estate:

<If China's household sector is successfully sucked into taking on debt,
local governments and developers won't use the opportunity to unwind their
leverage. They will likely double down and expand further. Local
governments are incentivized to spend as much as possible. Property
developers must follow their wishes. The end result is to create a bigger
problem, taking down the household sector without saving anyone else. ...

[A]s I travel around the country, I hear local government officials all
complaining about insufficient funding. As land sales have cooled in 2012,
some local governments are having trouble meeting payrolls. ...

It is quite likely that local governments will resort to new ways to raise
money from the household sector. Such measures will increase the tension
between the government and the people. The tension will be especially
acute in small townships where governments will have trouble paying
employees whose numbers have mushroomed in the past decade.

The government's appetite for spending is a major source of instability.
The internal pressure within government is for more spending. Without
checks and balances, the government is likely to search for more and more
revenue through oppressive means, destabilizing society along the way. [8]>

However, there are also sizable political risks involved in hanging the
local cadres out to dry. Few efforts of the liberal wing of the party, let
alone the party overall, are awarded with unstinting popular gratitude.

China's dissident community is trying to universalize - and nationalize -
the sufferings of the people of Shifang. If the proverbial spark ignites a
wildfire, one can expect the reformists to retreat and a lurch to the
hardline with central government support, muscle - and money - flowing
back to embattled local cadres.

And then China's ugly fiscal and financial picture will only turn uglier.

Notes:

1. Click Here 
<http://www.shifang.gov.cn/default/news/shownews/20111220171920949/20120703
20209288.html> for text (in Chinese).
2. China to clean up local gov't debt
<http://en.ce.cn/Business/Macro-economic/201206/28/t20120628_23443193.shtml
>, China Economic Net, Jun 28, 2012.
3. Moody Says China's Local Debt was Understated by 3.5Trl Yuan
<http://english.caijing.com.cn/2011-07-05/110765837.html>, Media, Ciajing,
Jul 5, 2011.
4. Click Here <http://finance.ifeng.com/roll/20120629/6677680.shtml> for
text (in Chinese).
5. Debt sales of Chinese regional governments reach record high
<http://gulfnews.com/business/banking/debt-sales-of-chinese-regional-govern
ments-reach-record-high-1.1042829>, Gulf News, Jul 2, 2012.
6. Xu Xiaonian: Local Gov may Consider Selling State Assets to Repay Debt
<http://english.caijing.com.cn/2011-08-22/110820921.html>s, Caijing, Aug
22, 2011.
7. Local Gov's Property Retreat "Dead on Arrival"
<http://english.caijing.com.cn/2012-06-27/111914375.html>, Caijing, Jun
27, 2012.
8. Dealing with a Double Whammy
<http://english.caixin.com/2012-06-29/100405636_2.html>, Caixin, Jun 29,
2012.

Peter Lee writes on East and South Asian affairs and their intersection
with US foreign policy.

(Copyright 2012 Asia Times Online (Holdings) Ltd.)