China's National Balance Sheet (2015): Leverage Adjustment and Risk Management

In 2011, when China’s local government debt problem was brought into the spotlight, foreign institutions started to voice pessimistic views on the prospects of China’s economy. In response to this, the Chinese Academy of Social Sciences (CASS) established the national balance sheet research group in a bid to carry out in-depth analysis of the sources, status quo and development prospects of the debts of governments at all levels and various types of economic entities in China, assess the sovereign debt risks, judge the national capacity and explore the countermeasures. In 2012, we completed the preparation of China’s sovereign balance sheet simultaneously with two other domestic research groups. The main findings of this research group were published in Issue 6 and 7 of Economic Research in 2013 and later expanded into a book entitled China’s National Balance Sheet 2013—Theory, Methodology and Risk Assessment, which was published by China Social Sciences Publishing House (2013). These findings have attracted wide attention at home and abroad: they have been widely cited domestically; their English versions have also been included in the monograph published by IMF. In 2015, the paper and the book won the first Sun Yefang Financial Innovation Award and the National Soft Science Award.

According to the System of National Accounts (SNA2008) and the preparation method of the National Bureau of Statistics (2007), we have tentatively prepared China’s national balance sheet of 2012–2013 using publicly available data and necessary estimates on the basis of preparation of China’s national balance sheet of 2007–2011.

We have updated the data of 2012–2014 (see Table 3.1) using the estimation method used previously by the research group for sovereign balance sheets and data sources as well as publicly available data and necessary trend extrapolation method.

By definition, all the debts in the household sector are loans rather than bonds.

In the past two years, local government debt has attracted continuous attention of people from all walks of life. Particularly, the amendments to the Budget Law, and the Opinions of the State Council on Strengthening Management of Local Government Debt (No. 43) issued in the second half of 2014 have outlined the new structure of the local government debt management system. On this basis, the Reviewing and Screening Measures for Placing the Outstanding Debts of Local Governments under Budgetary Management was issued, and two local government debt swap programs each amounting to RMB1 trillion were launched in the first half of 2015. In such case, we need to re-assess the risks of local debts and analyze and investigate some new trends. Therefore, in this chapter we have tentatively prepared the local balance sheet of 2012–2014 using new data and improved methods, assessed the main risks posed by local government debt based on the results of two rounds of comprehensive audit of local government debt conducted by National Audit Office and analyzed several key issues on preventing local government debt risks.

Since the outbreak of the international financial crisis, government balance sheets have aroused widespread attention. Promoted by Li et al. (The National Balance Sheet 2013—theory, method and risk assessment. China Social Sciences Press, 2013), some new results have been achieved in the researches on the balance sheets of the related countries. The Government Asset and Liability Accounting Theory and Policy Research Group (hereinafter referred to as the research group of the People’s Bank of China) prepared the Chinese government’s balance sheet (2012–2013) in 2015. In this book, we first carried out a superficial analysis of the Chinese central government’s balance sheet based on the results of the Chinese government’s balance sheet and then extended it to form the general central government balance sheet and then made a simple estimation of the central government balance sheet for 2012–2014 under the framework of the national balance sheet.

Since the outbreak of the international financial crisis, government balance sheets have aroused widespread attention worldwide (Li et al. in Econ Res J 1, 2(6, 7), 2012; Li et al. in China’s national balance sheet 2013—theory, methodology and risk assessment, China Social Sciences Press, 2013; Ma et al. in Research on China’s national balance sheet, Social Sciences Academic Press, 2012; Yuanzheng and Ma in Asking advice for the national balance sheet. Caijing Magazine 15, 2012). In addition to the government and sovereign balance sheets, the balance sheets of the sectors such as households, non-financial corporations, financial institutions and the external sector are also important research targets. The best way to prepare the balance sheet of the non-financial corporation sector is undoubtedly to combine the balance sheets of all related non-financial corporations, i.e., to add up the asset, liability and equity items of all non-financial corporations to get the consolidated balance sheet. However, not every enterprise in the real economy regularly compiles its standard balance sheet. Even if enterprises compile their balance sheets, it is also an arduous task to collect and sort out the relevant data, so this ideal method is too costly and not operable.

Theoretically, the financial sector balance sheet should include two levels: first, the balance sheets (summary) of various financial sub-sectors (including the central bank, banking, insurance, securities and trust etc.); second, the consolidated balance sheet of all financial institutions in the financial sector.

A central bank is a kind of special financial institution, so its balance sheet is different from those of other financial institutions. A central bank is an institution that is not intended to make a profit, so the changes in its balance sheet are not the asset allocation made by the central bank based on market returns and risk expectations, but centrally reflect the changes and adjustments of a country’s monetary policy. As the monetary policy operations vary in different countries, the structures of the central bank balance sheets of different countries are also greatly different. Meanwhile, in different historical periods, the changes in economic and financial systems and environments will affect the choice of monetary policy instruments. This determines that there are not only large differences in total assets/liabilities but also great differences in the asset/liability structures in the balance sheet of a country’s central bank in different historical periods. For example, the total assets and liabilities and asset/liability structure of the Fed in 2008 were greatly different from those after the 2008 subprime mortgage crisis. Similarly, the total amount and structure of China’s central bank balance sheet have been constantly changing in different time periods since the reform and opening-up. It reflects the changes in the adjustment means and mechanism of China’s monetary policies and the historical changes in China’s financial system. Therefore, observing the changes in the central bank balance sheet is also one of the approaches to understand and observe a country’s monetary policies.

The external sector balance sheet (stock) and economic aggregate (flow) reflect a country’s International Investment Position (IIP) and Balance of Payments (BOP) respectively. Studying the assets and liabilities of the external sector and grasping the total amount and structure of China’s external economy will help to make clear the real resources that can be mobilized and possible financial risks in the face of external shocks and thus enable us to take corresponding countermeasures in time.