A growing number of local government-owned enterprises in China have begun pulling back from funding regional projects, aiming to transform themselves into market-driven entities as Beijing doubles down on efforts to reduce the country’s implicit debt risks.
China’s new leadership team is scrambling to get on top of financial risk, especially among local governments that had their finances stretched by Covid control measures, while at the same time witnessing a plunge in revenue from land sales and taxes.
Implicit government debt refers to liabilities the government may eventually take some repayment responsibility for, despite being generated by state-owned enterprises (SOEs) or financing vehicles.
Concerns about financial contagion have turned de-risking into a government priority over the next five years, with Beijing establishing a powerful new agency, the Central Finance Commission, to oversee the issue at the “two sessions”.
The government will maintain high pressure on local debt management and reduce implicit liabilities
Authorities are also keeping a close eye on potential spillover from turbulence generated by the collapse of Silicon Valley Bank in the United States.
“Overall, the government will maintain high pressure on local debt management and reduce implicit liabilities,” Tan Yiming, an analyst of Minsheng Securities, wrote in a note earlier this month.
Suzhou city in east China’s Jiangsu province announced in mid-March that 18 locally owned enterprises will no longer undertake government fundraising and will be responsible for their own profits and losses.
More than 180 local government financing vehicles (LGFVs) – which were created to skirt restrictions on local government borrowing – in the province announced a similar transformation plan from December.
The move is a way to curb implicit liabilities from the borrowing side and showed greater effort to reduce risk at the source, according to an analysis by Ping’an Securities last week.
Speaking at the central economic work conference in December, President Xi Jinping explicitly said authorities must prevent SOEs or public service units from becoming new fundraising platforms and pledged to transform financing vehicles.
The Chinese leader also ordered officials to clamp down on so-called hidden debt – or off-balance sheet borrowing – optimise debt maturity structures, and reduce the interest payment burden on public debt.
LGFVs have thrived across the country because they provide financing in addition to tax revenue and land sales. About a decade ago, China had thousands of financing vehicles, which issued bonds or borrowed from banks to fund the constructions of roads, urban facilities and other projects.
Corporate bonds from LGFVs drew domestic investors in the past because they were widely deemed as financially guaranteed by local authorities, like municipal bonds, even though China’s budget law in 2015 excluded them from government responsibilities.
A public default by LGFVs would be a shock to this system and threaten financing flows to local projects
Many financing vehicles approached the brink of default during the pandemic. A government-controlled platform in the southwestern city of Zunyi last year proposed rolling over 15.6 billion yuan (US$2.2 billion) of maturing debt in 20 years, shocking the investor community.
Zhang Xiaoxi, a researcher with Gavekal Dragonomics, said last month that a potential bond-market blow-up could undermine the country’s economic recovery and threaten its financial stability.
“A public default by LGFVs would be a shock to this system and threaten financing flows to local projects,” Zhang said.
China’s outstanding local government debt is 35.7 trillion yuan, including 14.5 trillion yuan of general bonds and 21.2 trillion yuan of special purpose bonds, with its repayment covered by project revenues.
Estimates of implicit debt are even higher, with most concentrated in financing vehicles and SOEs.