China’s debt-ridden local governments face rising pressure to repay debt, and fallout from possible property-developer collapses could be crushing

A number of policy advisers to Beijing have been urging the central government to bail out indebted local governments, pointing to how a prolonged property market downturn could further weaken finances at local governments, which play a critical role in supporting the national economy.

US rating agency Moody’s Investors Service estimated that, since September, a total of 17 provincial governments have announced the combined issuance of more than 700 billion yuan (US$96 billion) worth of special refinancing bonds to repay debts from local government financing vehicles (LGFVs) – platforms created to aid off-budget financing.

“If Country Garden collapses, it may also put other large private developers in danger. If developers continue to fail one after another, [the scale of] local government debt will definitely continue to expand,” Zhang Ming, deputy director of the Institute of Finance at the Chinese Academy of Social Sciences (CASS), said last month at a seminar arranged by Peking University.

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Xu Gao, chief economist at Bank of China International, said that the “China model” of prioritising infrastructure investment to boost growth is successful only because the central government is always going to be the lender of last resort for local governments.

“That’s why local government debt became a big problem as the real estate industry fell into a vicious cycle for the past two years,” Xu said in a blog post published on the China Chief Economist Forum website on October 8.

“In other words, if one local government defaults, it would bring about a systemic crisis and trigger a market sell-off of the debts of various local governments, and even the central government’s,” Xu warned, adding that local government debts are also debts of the central government.

The International Monetary Fund (IMF) said last week in the October update of its World Economic Outlook that China’s economy needs to pivot away from a credit-driven real estate model of growth.

“Restoring confidence requires promptly restructuring struggling property developers, preserving financial stability, and addressing the strains in local public finance,” the IMF said.

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