China’s Time Bomb

Local government debt in China is a time bomb waiting to go off. In 2008 alone, propelled by the central government's stimulus package, local government debt grew by 62 percent. Seventy-nine percent of that borrowing consists of bank loans. This poses a threat to an already weak Chinese banking system.

For poorer areas, a sharp reduction of local public investment would mean a drop in employment and a rise in poverty.

The level of local government debt is not necessarily unsustainable. Most of it is used for business investment. Fifty percent of the debt goes to the most productive region of the country -- China's eastern provinces. And most of it is used to finance spending on assets: 62 percent went to infrastructure (urban development, airports, transportation, etc.) and 11 percent to land reservations. It is possible that some assets could be sold for debt repayment, but investment values for local government would be reduced and other debts would remain.

With these debts, tension between the central and local governments may rise when China enters the post-stimulus period. As central funding becomes more scarce, negotiations over transfer payments to local governments will become fiercer.

For poorer areas, a sharp reduction of local public investment would mean a reduction in employment and a rise in poverty. Small- and medium-sized firms in the private sector will suffer the most from a lack of available bank loans as lending policy is tightened to reduce high inflation. Bankruptcies for these firms have already began to soar and the consequences are concerning. The recent riot between Sichuan migrant workers and Chaozhou entrepreneurs in Guangdong arose because a firm was short of funds to pay its workers. Reports show many similar firms are nearing bankruptcy.

Reduced investment will slow China's G.D.P. growth. The impact of the international recession on Chinese economy, although delayed, will eventually appear. Crisis is the spur for change. Will the challenges be met? Only time will tell. By Lina Song professor of economic sociology and social policy at the University of Nottingham.