China’s central government has rolled out a new round of measures since the second half of last year to help local governments swap or restructure their off-the-books borrowing in a bid to control debt risk.
However, the sheer scale of the country’s local government hidden debt — up to more than 70 trillion yuan ($9.8 trillion) according to some estimates, more than twice Germany’s GDP — means that the measures at best are far inadequate and will provide only temporary relief to what experts say is a looming liquidity crisis for regional authorities.
At worst, it could further inflame the problem, promoting more off-the-books borrowing and increasing risk to economic and financial stability in the world’s second-largest economy, whose wobbly post-pandemic recovery has investors spooked, dragging the benchmark CSI 300 Index down 11% last year.
Local government financing vehicles (LGFVs), state-owned companies set up to borrow on behalf of local authorities, are responsible for the heaviest burden of local government hidden debts, which are usually taken out to invest in public projects such as highways and bridges.
China’s regional governments have long resorted to borrowing via LGFVs to help fund infrastructure investments to boost growth.
The issue of hidden debt has gained more urgency as local governments, especially poorer ones, have been struggling to repay the principal and interest. Compounding the problem is that many have run their coffers down implementing Covid control measures during the three years of the Covid-19 pandemic.
A prolonged property market downturn has also left holes in local balance sheets, as a big chunk of their revenue source — proceeds from selling land to developers — shrank.
Beijing’s response
Policymakers have been trying to resolve the problem for years, allocating quotas for local authorities to bring their hidden debt into their official budgets.
While previous plans to resolve hidden debt took a more piecemeal approach, the most recent measures, which the top leadership at a July meeting called a “package of debt-resolving plans,” have prompted cities and provincial-level regions across the country to issue more than 1 trillion yuan of “special refinancing bonds” to repay some of their off-the-books debt.
The proceeds will mainly be used to repay local government hidden debt that had been recorded by the Ministry of Finance by 2018 and will mature by the end of 2024, and will also be used to pay certain government arrears owed to businesses, sources with knowledge of the matter told Caixin. The total issuances in this round may end up raising 1.5 trillion yuan, they said.
Meanwhile, since September, the central government has been instructing commercial banks in 12 heavily indebted provincial-level regions to restructure LGFVs’ non-standard debts or swap them for bank loans with longer maturities and lower interest rates, in a bid to relieve repayment pressure on local authorities and LGFVs. The program has now been expanded to cover all the other provincial-level regions on the Chinese mainland, sources with knowledge of the matter told Caixin.
Non-standard debt usually refers to debt that isn’t traded on the interbank market or stock exchanges, such as trust loans, acceptance bills and accounts receivable. While LGFVs have never defaulted on bonds, some have on non-standard debt.
Last week, Finance Minister Lan Foan said in a press briefing that local government debt risks have been “mitigated overall” and are now “controllable.” The central government will further promote the implementation of the package of plans to resolve local government hidden debt, he said.
Still, many problems are left unsolved even as more hidden debt is being swapped for low-cost bank loans or on-balance-sheet local government bonds.
One problem is that despite the ban on local authorities from providing implicit guarantees for LGFV bond repayments, the rescue package reinforces investor belief that these bonds won’t default because the government will come to the rescue. Thus, in a spiraling cycle, investors are again scooping up these debt instruments.
Simply put, instead of discouraging the issuance of LGFV bonds, the package has made the bonds in hot demand again.
“It suddenly feels like all LGFV bonds are safe, although it’s uncertain how long this will last,” said a mutual fund manager who invests in LGFV bonds.
LGFV bond issuances in the third quarter raised 1.5 trillion yuan, a 7% increase compared with the previous quarter, with net financing also growing 4.2% quarter-on-quarter, according to data compiled by financial information provider East Money Information Co. Ltd.
Non-standard debt
Regardless, the government is forging ahead.
In September, the State Council issued a document instructing financial institutions to play their role in resolving local governments’ implicit debt, sources with knowledge of the matter told Caixin. Financial institutions should focus on the 12 regions under especially heavy debt burdens, and ease the risks associated with their LGFV debts set to mature by the end of 2024.
Authorities in Chongqing, whose GDP ranked No. 5 among all mainland cities in 2023, have been at the forefront of the effort. The city’s financial regulatory bureau established seven task forces to investigate hidden debt in each district, sources with knowledge of the matter told Caixin.
Meanwhile, authorities in the city asked 10 banks to handle hidden debt-resolution work in county-level districts, the sources said. The banks were told to deal with both LGFVs’ bonds and high-cost non-standard debt.
The Chongqing government hoped to swap all non-standard LGFV debt for bank loans and thus reduce the cost of borrowing to below 5%, according to a government source who works with state-owned assets.
On Dec. 8, multiple banks in Chongqing, led by a local branch of state-owned Agricultural Bank of China Ltd. , swapped 50 million yuan of non-standard debt owed by an LGFV for bank loans, according to a Dec. 11 report published by local paper Chongqing Daily. However, the report was taken down from its website within days.
Non-standard debts have become a focus of the country’s latest effort to resolve hidden debt, as the high returns they offer to investors, which can go above 10% in some cases, mean high financing costs.
Taian, a city in East China’s Shandong province, vowed to swap all of certain local state-owned companies’ non-standard financing with annual interest rates between 9% and 12%, in a bid to prevent debt defaults, local media reported in October.
Banks vs. LGFVs
Chongqing isn’t the only place that is closely combing through its hidden debt. Many other local governments have also set up task forces to assess hidden debt and compile a list of LGFVs, sources at major state-owned banks told Caixin.
The focus, they said, is on LGFV bonds and non-standard debt that will mature by the end of 2024, although LGFVs can negotiate with financial institutions to address debts that will mature at a later date.
The path to swapping non-standard debt isn’t plain sailing.
Local authorities would like to swap non-standard debt for bank loans with minimum interest rates and maturities of 20 to 30 years, and it’s best for them if there’s no need to pay any principal or interest in the first five years, but such deals are hard for banks to stomach, banking sources told Caixin.
“Banks aren’t very enthusiastic (about swapping LGFV debt),” the Chongqing government source said. They are mainly extending or swapping debts owed to themselves, or cutting their interest rates, as a way of fulfilling a “political mission,” he said, adding that some banks ask for new collateral for the swaps.
A source who works for an LGFV in northern China said working with banks has been time-consuming, because each bank has its own requirements.
Banks may consider issuing new loans to swap LGFV debt if the borrower is suffering from short-term liquidity pressures, the proceeds have been invested in financially sustainable projects, and a concrete debt-resolving plan is in place, according to banking sources.
In principle, the new loans shouldn’t have a maturity longer than 10 years, and the borrower should repay at least 10% of the principal every year, a person at a major state-owned bank said.
If an LGFV can’t repay its debt, and the debt doesn’t meet requirements for being restructured or swapped at a bank, the local authority can apply for emergency liquidity support from the central bank, banking sources said.
The total amount of such support available is around 1.3 trillion to 1.6 trillion yuan, multiple sources with knowledge of the matter said.
No panacea
Debt restructuring or swaps, either through banks or special refinancing bonds, will only provide temporary relief against an imminent liquidity crisis, scholars and analysts said.
These measures may not be sufficient to prevent localities from taking on more hidden debts, and a long-term cure requires a revamp of how fiscal revenues and spending obligations are split between the central and local governments, they said.
Scholars, including Zhang Ming, a deputy director of the Institute of Finance and Banking at the Chinese Academy of Social Sciences, have called for rebalancing the country’s systems for tax sharing and fiscal expenditure.
To help local governments balance their income and expenditure, Zhang suggested that new taxes be levied with most of the revenue going to local authorities. Meanwhile, certain spending, such as pension and medical insurance expenditure, can be managed by higher levels of government, he wrote in a recent article.
On the other hand, Qiao Baoyun, head of the China Academy of Public Finance and Public Policy at the Central University of Finance and Economics, said the root of local governments’ debt problem is insufficient checks on how they spend their money.
Luo Zhiheng, chief economist at Yuekai Securities Co. Ltd, suggested that local governments should be downsized — both in terms of responsibilities and headcount — so that the market can play a bigger role in deciding how money should be spent.
Source:Caixin