Early Warning Model of Local Governments Debt Risk in China Based on the Financial Perspective

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1 Early Warnng Model of Local Governments Debt Rsk n Chna Based on the Fnancal Perspectve Feng Zheng & Feng Ye School of Management, Shangha Unversty of Engneerng Scence, Shangha, Chna, Major: Busness Management Assocate Professor, Senor Engneer, School of Management, Shangha Unversty of Engneerng Scence, Shangha, Chna. Research drecton: Engneerng Management, Town Plannng, Envronmental Economcs. Correspondence: Feng Zheng, Wenhu Road 000 Lane, The 8th buldng, Room 507, Songjang Unversty Town, Songjang Dstrct, Shangha, Chna. E-mal:538093@qq.com Receved: November 8, 03 Accepted: December 0, 03 Onlne Publshed: December 5, 03 do:0.5430/bmr.vn4p9 URL: Abstract By studyng Chnese government local debt scale, analyzng cause and rsk, we can draw the concluson local government debt n Chna s brewng a crss. Apparently, t s the crss n the fnancal control, but t may not only fnancal control crss, and t may lead to fnancal overall crss, or even cause the Government s overall governance crss. Fnally, usng multlevel structure analyss and by the means of nde system made from economcs, socal uncontrollable eogenous factors, ths paper puts forward the debt rsk assessment consst of converse nde and postve ndcaton. At the same tme, t uses the Delph method to weght nde for the purpose of reducng subjectve measurement and evaluaton. On ths bass, we hope to gve same suggeston to the government for avodng the debt rsk. Keywords: Local government Debt, Rsk, Early warnng model, Rsk assessment. Introducton Accordng to the Chna Natonal Audt Offce for the frst tme on the local fnancal revenue and ependture audt results, as of the end of 00, the local government debt balance s 0.7 trllon Yuan, s equvalent to 7% of the Chnese economc output. And 0, 03, 04, respectvely, 7.7%,.37%, 9.8 of the debt maturty. Ths means that Chna wll enter a peak perod of local debt repayment. From the foregn meda, Aprl 7, 03, "Fnancal Tmes" sad, Chna's local debt s out of control; Aprl 9, one of the three major nternatonal ratng agency Ftch downgraded Chna's soveregn credt ratng; another major nternatonal ratng agency Moody cut Chna's Soveregn credt ratng outlook form postve to stable. Ths s the nternatonal ratng agency frst tme downgraded Chna's soveregn credt snce 999. Two nsttutons have ponted out n ts report, the rapd ncrease n local government debt and ts opacty have a great mpact n Chnese fnancal system s stablty. So far, Chna's local government debt once agan aroused strong concern of all over the world.. Chnese local government debt stuaton. Sze of the debt Chna Audt Commsson released 0 audt report data show that as of the end of 00, Chnese natonal local government debt has reached a total sze of the balance of trllon Yuan. Includng government bears the responsblty to repay the debt, Government bears responsblty for the debt guarantee and other debt whch the government may bear some responsblty for (see the fgure ). Publshed by Scedu Press 9 ISSN E-ISSN 97-60X

2 Other debt 5% Sze of the debt Government bears responsblty for the debt guarantee % Government bears the responsblty to repay the debt 63% Government bears the responsblty to repay the debt Government bears responsblty for the debt guarantee Other debt Fgure. the scale of the natonal local government debt statstc. The growth of local government debt stuaton In response to the Asan fnancal crss, varous parts of the local government response to the central government's postve fscal polcy through substantal fnancng to ncrease nfrastructure and other publc goods nvestment. So snce 997, Chna's local government debt has mantaned a rapd growth, the average annual growth rate of 0% or more, ncludng rapd growth n , one year from 4.8% n 997, rapdly growth to 998 of 48.0%. From 998 to 008, the growth rate of local government debt declned, and n 008 reached a low pont of 3.48%, whch s Chna's economc soft landng polces adopted correspond; however, ths trend made a turnng pont after 008, n response to the global fnancal crss, local government debt fnancng agan played a role n makng 009 the debt balance ncreased by 6.9% over the prevous year. Wth the local government debt problems gradually eposed, and by the end of 009 Chna begn to start the mplementaton of local government debt nventory and management mechansms, so 00 debt balance growth rate dropped to 8.86%. November 0 to February 03, Chna Natonal Audt Offce carred out spot checks on 36 local governments, estmates, n 0 Chna local government total debt about. trllon Yuan (see the fgure ). RATIO 70.00% 60.00% 50.00% 40.00% 30.00% 0.00% 0.00% 0.00% -0.00% 6.9% 48.0% 33.3% 4.8% 6.3% 3.48% 8.86% YEAR Fgure..3 Sources of local debt fundng Natonal local government debt fundng sources, the end of 00, bank loans are the most mportant component of local government debt, totaled trllon Yuan, accountng for 79.0 percent of the debt, So the local government debt problem est sgnfcant mpact on Chna's fnancal system rsks (see the fgure 3). Publshed by Scedu Press 30 ISSN E-ISSN 97-60X

3 The credtors Amount of debt (unt: mllon) Proporton Bank loans % Fscal from superor government % Bonds ssue % Other debt % Total % Fgure 3..4 Areas debt funds nvest to Debt s manly used for muncpal constructon, transportaton, other land and publc products purchase, the proporton reached 86.54% of total debt; Specfcally muncpal buldng, the number reached trllon Yuan, accountng for 36.7 percent of the total (see the fgure 4). Areas debt funds nvest to Amount of debt (unt: mllon) Proporton Muncpal constructon % Communcaton and transportaton % Land purchasng and storage % Educaton, scence, culture, health and low-ncome house % Agrculture, forestry and water conservancy constructon % Ecologcal constructon and envronmental protecton % Funds of defuse local fnancal rsks % Industry % Energy % Others % Total % Fgure 4..5 Debt repayment tme 0 to 05 s the prncpal tme to repay the debt, reachng 7.5 trllon, accountng for percent of total debt; ndcatng that local government debt fve years wll be great pressure (see the fgure 5). Debt repayment tme Amount of debt (unt: mllon) Proporton % % % % % 06 and beyond % Total % Fgure The local government debt rsk early warnng model As for Chnese local government debt stuaton has made the detaled ntroducton above, we can clearly recognze that the Chnese local government debt have certan crss, whle Chna's local debt funds manly come from Chnese bankng system, so once the debt crss outbreak wll caused great mpact on Chna's fnancal system, therefore the assessment and early warnng mechansm of local government debt rsk establshed can make the debt management became more standard whch contrbute to local government mplement metculous management for debt. Establsh local government debt rsk model have to acheve three functons: frst, early warnng functon, through a seres of eplct and mplct data to buld early warnng ndcators, crtera, nde, n order to reach the purpose of debt rsk early warnng; second, tmely montorng functon, montor and control the scale and structure of all knd debt, analyss the trend of local government debt rsk and comprehensve evaluaton; thrd, the functon of budget, accordng to each tem of debt related parameters and the default rate, determne the sum of debt funds future needed to repay, whch can form a long-term, rollng debt budget system. Publshed by Scedu Press 3 ISSN E-ISSN 97-60X

4 3. The local government debt rsk early warnng nde selecton We can t analyss government debt problem on local fnance only from the angle of debt data. Analyss the local government debt rsk has to not only based on debt data, but also need to compare the related ndees of the local poltcal, economc and socal development together. We only consder the local government debt est securty rsk when t mpact the local socety and economc structure. In vew of ths, the author selects 4 ndees from three aspects of economc, poltcal and socal, whch can comprehensvely assess the local government debt rsk. These ndces nclude the debt burden rate, dependence degree of debt, debt borrowng rate, debt servcng rate, the local debt per capta rate, debt overdue amount, the government fscal revenue defct rate, the proporton of fscal revenue, ndustral economc effcency of enterprses, local government fscal revenue ta rate, household debt burden rate, unemployment rate, per capta GDP and the contrbuton rate of fscal ependture. The rate of debt burden, reflects the total sze of the debt, whch measure debt rsk status from total amount. Because of the economc development level of each country s dfferent, the proporton of debt burden rate control requrements are dfferent, the developed countres generally beleve that the debt burden rate less than 45%, the government can control the rsk, whle the EU debt burden rate s lmted to 60%.Accordng to 0 Chna government data, Chna s rate of debt burden s appromately 30%. Dependence degree of debt reflects how much fnancal ependture s reled on debt to acheve. Internatonal eperence shows that the warnng lne s 0%.Debt borrowng rate (amount of new debt / the area total GDP) reflect the government's new debt accounted for the proporton of the natonal economy, whch measure the economc rsk caused by the new debt. Debt servcng rato reflects the annual debt servce burden rate, s generally beleved that the debt servcng rato warnng lne s 0% nternatonally. The local debt per capta rate reflects the local per capta burden of debt and the stuaton of the local government debt. Debt overdue amount reflects the stuaton of potental rsk of debt nto government debt crss, also s the estmate of the hghest debt rsk of local government. The government fscal revenue defct rate reflects the local government s debt capacty accordng to ther economc development, s generally beleved that the government fscal revenue defct rate warnng lne s 3% nternatonally. The proporton of fscal revenue reflects the ablty of GDP transform nto government revenue, the hgher the value of nde, the ablty of government debt rsk management s stronger. Local government fscal revenue ta rate reflects the local enterprse s ablty to bear the government debt rsk. The hgher household debt burden rate ndcates that the government transfer of debt drectly to local resdents s more dffcult. Unemployment rate reflects the local socal stablty condton. Per capta GDP reflects the regon's economc development level. The contrbuton rate of fscal ependture reflects the potental contrbuton of government debt. Specfc ndcators are shown n the followng table (see the fgure 6). Indees Formula Countng drecton Debt Burden Rate( ) Outstandng Oblgaton/GDP Backward Dependence Degree of Debt( ) Debt Revenue/ Fscal Ependture Backward Debt Borrowng Rate( 3 ) Amount of New Debt/GDP Backward Debt Servcng Rate( 4 ) Debt Payng Ablty/ Fscal Ependture Backward The Local Debt per Capta Rate( 5 ) Local Debt Balance/ The Total Populaton of the Backward Local Area Debt Overdue Amount( 6 ) Overdue Debt Balance/ Outstandng Oblgaton Backward Government Fscal Revenue Defct Revenue Defct/GDP Backward Rate( 7 ) Proporton of Fscal Revenue( 8 ) Fscal Revenue/GDP Forward Industral Economc Effcency of Gross output of ndustral enterprses/gdp Forward Enterprses( 9 ) local Government Fscal Revenue Ta Revenue/ Fscal Revenue Forward Ta Rate( 0 ) household debt burden rate( ) Outstandng Oblgaton/Resdents Deposts Backward Unemployment Rate( ) (Workng Populaton-Employed Populaton) / Backward Workng Populaton per Capta GDP GDP/Populaton Forward the Contrbuton Rate of Fscal Fscal Ependture/GDP Forward Ependture Fgure 6. Publshed by Scedu Press 3 ISSN E-ISSN 97-60X

5 3. The constructon of local government debt rsk early warnng model Each nde of local government debt rsk early warnng nde system are reflects the local government debt rsk stuaton, but to reflect the total stuaton of local government debt rsk, we need to comprehensvely evaluate the nde. Snce each ndcator and measurement unts of local government debt rsk assessment and early warnng model are not the same, so can t be smply added. Most of these ndcators are just relatvely ndcators, and some are per capta ndcators, whch meanng and degree of mportance s not the same, so smple sum does not reflect the degree of mportance of each ndcator and ts role n rsk assessment. I m adopted the herarchy analyss method to establsh the nde, whch on the bass of the nde ncrement. Accordng to the local government debt rsk assessment and early warnng model, assumng the 0 for a perod of ntal I nde, and for the nde value at end of perod, so the local government debt rsk ncrement n the nde value are: Y = - 00 (when the 0 s forward) () Y = 0 00 (when the s backward) () Let Y be a numercal means the nde, P s the weght of nde, R for local government debt rsk factor, there are: R= Y P (3) As can be seen from the above model, by comparng the ntal numercal value of the local government debt rsk assessment and early warnng ndcators wht the pror perod s fgure, whch can get the ncremental value of debt rsk of nde of local government debt rsk n the current assessment perod. Base on the consoldated results of the assessment scores, can assess the comprehensve rsk of local government debts, the larger the value, the hgher local government debt rsk, and the greater securty rsks. 3.3 Determnaton of local government debt rsk early warnng nde The nde weght of the model s the formula (3) P. Select reasonable weght or not has a decsve nfluence on the local government debt rsk assessment and evaluaton. Ths paper uses the method for determnng the weght s the Delph Technque. Ths paper uses the Delph Technque to set the ndcators very mportant, mportant, general, unmportant, very unmportant to fve levels respectvely. Accordng to the mportant of each level are respectvely set to 4 to 0 score whch facltate numercal summary rankng for each nde, as shown n the followng table (see the fgure 7). Gradng Score Very mportant 4 Important 3 General Unmportant Very Unmportant 0 Fgure 7. Accordng to the results of a questonnare survey and epert advce, gve weght to each nde, and then we can calculate the local government rsk factor R accordng to the weght and value. Establsh the early rsk warnng rang n lne accordance wht the magntude of R. Frst the value of R lmts can be set, calculaton and analyss of the boundary values by usng the GARCH model, can determne the three regons whch generate three new sequences. Then accordng to the nde value set securty zone, mark as: Ysn ; smaller rsk zone, mark as: Ysn ; hgh rsk zone, mark as: Ysn 3. sn S ( ) Ysn Ysn -Ysn sn sn (4) S sn ) 3 Ysn ( Ysn3 Ysn sn3 sn (5) Publshed by Scedu Press 33 ISSN E-ISSN 97-60X

6 Ysn, Ysn, Ysn 3 denote three sequences sample mean and σsn, σsn, σsn 3 denote three sequences standard devaton. S s equal to the arthmetc average of S and S 3, as an ntermedate threshold to acheve safe separaton zone and danger zone. As a mddle threshold value whch to separate safety zone and danger zone. Of course, takng nto account the actual economc and socal envronment n dfferent part of Chna s dfferent, so need to set the debt rsk warnng lne s dfferent, and modfy the local government debt rsk nde system, to make the model results more correspond the actual stuaton of local economc operaton, whch can rase the debt rsk early warnng accuracy. 4. Local government debt crss preventon recommendatons At present, Chna's local government debt at the macro level s not serous, but serously affected the mcro level, debt of Some local government have apparent eceeded the reasonable affordablty. Therefore, take effectve measures and scentfc manage the local government debt s necessary acton for the Chnese government. Ths artcle puts forward four recommendatons to prevent local government debt rsk from a polcy and fnancal perspectve. 4. Improve estng local government debt measures Rectfyng government fnancng platform, ntroduce prvate captal and prvatze other fnancng platform. Implement the regulaton of the bonds ssued by the Mnstry of Fnance nto the budget management requrements. 4. Reform the estng fnancal system Frst, reform the government accountng system. Effectvely reform the estng government accountng prncples, realzaton of accrual bass nstead of the cash bass, n order to fully reflect the Government runs all recepts and payments n one fscal year. Second, speed up fnancal reform. Rght to face the ta system reform, fnancal power move up from the local government to central, and Admnstratve power down from central government to local, and pay attenton to the affar that the local governments nsuffcent fnancal resources. Reasonable to establsh fscal system whch the fnancal resources match the admnstratve power. Redefnton of the central and local government admnstratve powers and fnancal authorty, approprate adjust the central and local revenue dvson, whch can effectvely allevate the fnancal pressure on local governments. At present, Chna has been n Shangha, Zhejang, Shenzhen, Guangdong, four plot projects to carry out ther own bonds. Specfc mplementaton to acheve the followng: Amend the budget law. Allow a certan degree of local government budget defct, local government bonds eclusvely used to cover local defcts; mprove the government budget system, a varety of budgets are set up specal chapter dedcated to develop detaled terms; Establsh the debt budget specal seal. 4.4 Establsh the publc fscal system Ensure Chna's fscal can transparency operaton, whch s most effectve way to ensure the healthy operaton of local government debt, protect the prevent wdespread llegal and varous prvleges, corrupton and any unfarness and let the Chna debt system run smoothly. References Je Shu. (0). Try to talk about the concept of fnancal early warnng theory and ts theoretcal bass. New Fnance Economcs, 0(0). Jun Zhou. (008). The problems and suggestons n the constructon and use of fnancal early warnng model n Chna's enterprses, Journal of jnlng nsttute of technology, Junde He & Nansheng Zhang. (009). Research on fnancal rsk early warnng based on the modern fnancal theory. Scentfc and technologcal progress and countermeasures, 009(). Koyuncugl, A. S., & Ozgulbas, N. (007a). Developng fnancal early warnng system va data mnng. In Proceedngs Book of 4th Congress of SMEs and Productvty, Istanbul, pp Koyuncugl, A. S., & Ozgulbas, N. (009b). An ntellgent fnancal early warnng system model based on data mnng for SMEs. In Proceedngs of the Internatonal Conference on Future Computer and Communcaton, Kuala Lumpur, Malaysa. Ln, L., Pesse, J. (004). Identfcaton of corporate dstress n UK ndustrals -a condtonal probablty analyss approach. Journal of Appled Fnancal Economcs (4), Publshed by Scedu Press 34 ISSN E-ISSN 97-60X

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