China’s ‘hidden debt’ seen shrinking, but scaling that mountain remains a daunting challenge
LGFVs are hybrid entities that are both public and corporate, created to skirt restrictions on local government borrowing. And they have proliferated since the global financial crisis in 2008 as a way of funding China’s infrastructure-building spree, with few generating returns. The debt raised is kept off the balance sheets of local authorities, yet carries an implicit government guarantee of repayment.
There are no official figures on China’s hidden-debt pile, but various estimates in recent years have suggested it could be somewhere between 30 trillion and 50 trillion yuan. And much of the debt stems from informal channels of borrowing that involve LGFVs. In comparison, China’s gross domestic product (GDP) for all of 2023 was about 126 trillion yuan.
Japanese investment bank Nomura estimated that China’s local government hidden debts – comprising mainly LGFV debts, including loans and bonds – had reached 45 trillion yuan by the end of 2020.
On Thursday, the National Financial Regulatory Administration said that it would step up supervision of new debt accrued from LGFVs, as well as monitor the banking sector to prevent the growth of such debt.
In 2018, the Ministry of Finance asked local governments to clean up such hidden debt within five to 10 years. And at the end of 2022, former finance minister Liu Kun disclosed that those hidden debts had shrunk by more than one-third in the span of five years.
Meanwhile, risks of default for LGFV debt have risen significantly, mainly resulting from a fall in land sales – a key source of revenue for local governments.
LGFV’s primary function of funding infrastructure projects often fails to generate sufficient returns to cover debt payments, leaving many reliant on refinancing or government support to stay afloat.
Fitch Ratings estimated LGFV exposure at rated Chinese commercial banks – mainly state banks and joint-stock banks – account for up to 15 per cent of their assets at the end of 2023.
But banks in economically weaker regions, mainly city and rural commercial banks as well as rural cooperatives, face more imminent pressure from rising LGFV debt risks, Fitch Ratings said in a research note on May 14.
We assume the finances of local governments will stabilise as the Chinese property sector eventually bottoms
China’s Politburo, the highest policymaking body, said last year that it would formulate “a basket of plans” to resolve risks stemming from local government debt. Regional authorities were allowed to shift high-interest, short-term, off-budget LGFV debt to their balance sheets as longer-term and lower-cost bonds.
So, while the cost of borrowing, on average, for LGFVs has declined since last year, Luo at Yuekai Securities said that it was mostly the economically strong regions, and those with relatively high credit ratings, that have benefited so far.
Weaker regions such as Yunnan and Guizhou provinces still were not able to take full advantage of lower borrowing costs in the capital market and still struggled from funding shortfalls, Luo said.
US rating agency S&P Global Ratings estimated in a note on Thursday that local Chinese governments swapped 1.4 trillion worth of high-interest debt at the end of 2023.
“We assume the finances of local governments will stabilise as the Chinese property sector eventually bottoms, and governments stay disciplined on spending,” S&P predicted. “That said, immediate revenue pressures and continued spending intensity could delay China’s local and regional governments’ fiscal consolidation by another year.”