Local govt debt not 'fatal' issue

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French bank BNP Paribas SA said on Thursday that China's local government debt is not a "fatal problem", as Beijing is expected to publish the latest round of audits next month.

In the worst-case scenario, Chinese banks would suffer 1.87 trillion yuan ($306 billion) in losses, said Chi Lo, a senior strategist with BNP Paribas in Hong Kong. That would lower the banks' tier-1 capital adequacy ratios by 3.1 percentage points on average, but the ratios would still be at a high of 7.5 percent, 0.5 percentage point higher than the 7 percent level required by Basel III, which has yet to be implemented.

"Chinese banks are in a financial position so strong that even a systemic shock won't cause system breakdown," said Lo.

The National Audit Office started the latest round of audits of local government debt on Aug 1. Local media said audit work has already been completed and will be reported to the State Council - the country's cabinet - on Sunday. The results will be made public in November.

Stephen Green, head of Greater China research at Standard Chartered Plc, wrote in a research note on Thursday that he estimates the figure could be between 21.9 trillion yuan and 24.4 trillion yuan, 38 percent to 42 percent of the country's GDP, and nearly double the current official estimate.

But the figure should not surprise the market, he added, as it has already assumed a 20 trillion yuan debt level.

Green added that he expects the announcement of a higher official estimate to create momentum for fiscal reform and a more comprehensive approach to the problem of local government investment vehicles in 2014.

Lo estimated that if the local government debt is at 20 trillion yuan, the banks' tier-1 capital ratio will be lowered to 4.5 percent in case of a systemic shock. But still that's not the end of the world, as Beijing has plenty of tools that can easily shore up the banking system, Lo said. China's total debt, after all, is still at a healthy level, standing at around 200 percent of GDP in 2012.

Beijing will likely allow smaller institutions to go broke as part of reforms in the financial sector, Lo added.