China’s ongoing struggle with its local government financial vehicles (LGFVs) is posing a significant challenge for President Xi Jinping as he seeks to revive the country’s sputtering economy. The LGFVs, which were created by local governments during the 2008 financial crisis, were initially intended to bypass a central government ban on direct state borrowing. They were used to develop public infrastructure projects such as roads, railways, and airports. However, these entities have now accumulated a massive debt of 80 trillion yuan ($11.1 trillion), with the majority owed to Chinese banks.
The Chinese government’s attempts to separate the implicit guarantee between local governments and their LGFVs have largely failed, leaving Beijing with limited options for resolving the debt crisis. One potential solution is allowing local governments to raise 1 trillion yuan through bond sales to repay LGFV debt. Another option is for banks to extend loans and reduce interest rates. However, these measures would not address the underlying problem of LGFVs’ unsustainable debt levels.
A more drastic approach would involve a fire sale of LGFVs’ assets to generate much-needed cash. These assets include land, industrial parks, and transport infrastructure, which account for around 60% of LGFVs’ total assets. By selling these assets at a discount, the LGFVs could potentially raise enough funds to repay their outstanding bonds. However, local officials have resisted this option, arguing that many of these assets are illiquid.
The consequences of allowing LGFVs to fail could be severe. S&P analysts estimate that around 20 trillion yuan of LGFVs’ loans may be at risk of restructuring. If these loans were rolled over with reduced interest rates, it would result in a 5 trillion yuan hit to bank capital and could destabilize the financial system. The country’s banking sector already has 335 trillion yuan of total assets, and transparency regarding bad loans and impairments remains an issue.
China’s heavy reliance on investment rather than consumption for economic growth further complicates the situation. With investment accounting for 40% of GDP, Xi Jinping’s aversion to propping up the economy through real estate leaves him with limited options. Chinese households have significant savings, but they are hesitant to spend due to concerns about job security and the impact of the pandemic.
Moody’s, a global rating agency, recently revised down its forecast for China’s GDP growth in 2024 to 4%. It maintained that the country’s economy will grow at the government’s official target rate of 5% in 2023. The monthly economic update for August, including data on industrial output, fixed asset investment, property investment, and retail sales, is set to be released on September 15.
In summary, China’s struggle with its heavily indebted LGFVs presents a complex challenge for President Xi Jinping as he seeks to revive the country’s economy. The options before him are limited, with potential solutions ranging from bond sales and loan extensions to a fire sale of assets. However, the risks associated with these measures, including destabilizing the financial system, underscore the urgent need for action. As China’s growth relies heavily on investment rather than consumption, finding a sustainable solution to the LGFV debt crisis is crucial for the country’s economic recovery.
More detail via Reuters here… ( Image via Reuters )