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Updated Saturday, March 13, 2010 12:45 am TWN, Bloomberg

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China may be forced into 'massive' bailouts after stimulus

HONG KONG -- China may be forced to bail out banks that made loans for local-government projects under the unprecedented stimulus program unleashed in 2008, according to Citigroup Inc. and Northwestern University's Victor Shih. In a “worst-case scenario,” losses from lending to local-government investment vehicles could climb to 2.4 trillion yuan (US$350 billion) by 2011, Shen Minggao, Citigroup's Hong Kong-based chief economist for greater China, said in a note Friday.

“The most likely case is that the Chinese government will engineer a massive financial bailout of the financial sector,” said Shih, a professor who spent months researching borrowing by about 8,000 local government entities.

Chinese officials pledged this week to limit the risks posed by the investment vehicles, which circumvent restrictions on local-government borrowing to channel money into stimulus projects. Yan Qingmin, head of the banking regulator's Shanghai branch, said March 5 that China plans to nullify guarantees provided by local governments for some loans.

Citigroup's Shen said officials may keep monetary policy loose for longer than they should, boosting asset prices and building up overcapacity, to avoid the “squeeze” on investment vehicles that would trigger bad loans and bailouts.

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