China Faces ‘Mini Crisis’ on Debt Defaults, Ex-PBOC Adviser Says

[Demon of Light]

China is headed for a “mini crisis” in its local-government debt market as economic reforms lead to the first defaults, according to a former adviser to the People’s Bank of China.

“It will be a partial, controllable and mini crisis,” Li Daokui told reporters on the sideline of the Credit Suisse Asian Investment Conference in Hong Kong today. “There’s tremendous room for the central government to fix the problems in local government debt. Defaults must be allowed to restructure the debt, which will definitely happen as part of the reform measures in the second half of this year.” Li is a former member of the PBOC’s monetary policy committee and is director of Center for China in the World Economy at Tsinghua University.

China’s town and cities took on debt to pay for subways, sewage works and roads to help finance a 4 trillion yuan ($646 billion) stimulus package unveiled by the government at the height of the global financial crisis in November 2008, two months after Lehman Brothers Holdings Inc. collapsed. Those borrowings are still climbing and refinancing is growing costlier as default risk builds amid slowing growth in the world’s second-largest economy.

The amount owed by local governments jumped 253 percent since 2008, Nomura Holdings Inc. estimated in a Feb. 25 report, and official figures indicate the total increased to 17.9 trillion yuan by June 30 from 10.7 trillion yuan at the end of 2010. The nation recorded its first onshore bond default this month and a private Purchasing Managers’ Index released yesterday suggested factory output is shrinking in March at the fastest pace since July.

Source: Bloomberg

At the same time there are reports of a few minor bank runs in one area of China. This is all coming in the wake of several unrescued defaults among Chinese businesses. While such defaults are currently in line with Chinese efforts at reforming their economy by allowing these types of normal market actions, it is quite probable with the exorbitant debt loads in the domestic economy that this will get somewhat out of their control and cause a harsher slow-down than intended or even cause a contraction in their economy. China is particularly at risk of harmful bank runs given their lack of deposit insurance.

 

[Objective Voice]

I wonder how China's mini-economic crisis will affect the U.S. bond market? Should the situation get worse, there are only two ways this plays out where the U.S. is concerned:

a) China's stops buying U.S. bonds; or,

b) China's insists on receiving a higher interest rate on U.S. bond purchases.

Looking for an economist to chime in here with his/her :twocents: worth.