When the central government fails to rein massive spending at a local level, China might face an inflation of up to 15 percent by 2012, tells professor Victor Shih to BusinessWeek. The article focuses on Chongqing, the largest city in China in terms of population, and trying to get also its marks on the economy,
Local governments like Chongqing try to circumvent successfully efforts by the central government to stem government spending:
Chongqing, China’s wartime capital on the Yangtze River, is a prime example of how provincial governments multiplied the effect of the central government’s stimulus plan. The city had 900 billion yuan in loans and credit lines outstanding at the end of 2009, said Northwestern’s Shih. Chongqing’s economy expanded 14.9 percent last year, with investment in factories and property expanding the most in 13 years…
China’s local governments set up investment vehicles to circumvent regulations that prevent them borrowing directly. These vehicles borrow money against the land injected into them and guarantees by local governments, said Shih.
When the efforts of the central government fail, the consequences could be dear, Shih says.
The projects and their loans are stymieing efforts by Premier Wen Jiabao to curtail investment as inflation rose to 2.7 percent in February, a 16-month high. Failure to rein in local government spending could push inflation to 15 percent by 2012, said Victor Shih, a political economist at Northwestern University who spent months tallying government borrowing.
“Increasingly the choice facing the government is between inflation or bad loans,” said Shih, author of the book “Finance and Factions in China,” who teaches political science at the university in Evanston, Illinois. “The only mechanism for controlling inflation in China is credit restriction, but if they use that, this show is over — a gigantic wave of bad loans will appear on banks’ balance sheets.