Beijing has made one of the biggest top-down attempts in recent years to deal with the debts accrued by local governments. This is a sign that authorities are growing increasingly concerned about the threat to financial stability in the face of a faltering economy.
The State Council, China, which is the country’s Cabinet, has sent teams of officials into more than ten of the country’s most financially-weak provinces. They will examine their books, including the liabilities of off-balance-sheet entities, and look for ways to reduce their debt.
Two people familiar with this initiative reported that working groups from the central banks, finance ministries and securities watchdogs are involved in debt resolution efforts in these provinces. They will be reporting to Premier Li Qiang.
The huge debts accumulated in China’s provinces are an urgent issue for policymakers who want to stop the country’s reliance on debt-fuelled infrastructure to drive its economic growth. Goldman Sachs estimates that the total debt of local governments is Rmb94tn (about $13tn), which includes the liabilities of off-balance-sheet entities called local government financing vehicle.
A resolution of the debt would not only reshape regional investment and finance, but also lead to a repricing of local bonds and affect the shares held by regional banks who have lent heavily to LGFVs.
The two said that while the plans could change, it was important to categorise the “hidden debt”, which is money that doesn’t appear on the balance sheets of local governments and often comes from non-public sources.
They said that under the initiative, some debt could be exchanged for official local government debts while the remainder could be restructured.
According to a third source, the Finance Ministry is considering allowing local authorities to pay off their relatively high-interest LGFV loans using low-interest bonds for special purposes and other types of bonds.
The working groups will also pressure policy makers and commercial banks to extend loan terms to LGFVs and reduce interest rates.
The biggest disagreement between the central and local government was over who would pay for cleaning up. Beijing wants the provinces to liquidate assets to repay debt, but local officials argue that many assets are not liquid and that central government should do more to assist with rescues.
Three people have said that the groups could continue to push local authorities to sell assets in order to pay off their debts and to stick to the principle no direct bailouts from the central government to avoid moral hazards.
The plans were drawn up by China’s top decision-making body, the politburo. It is chaired President Xi Jinping. In July, it promised to “formulate and execute a package” of plans that would help reduce local government debt.
Since 2015, China has repeatedly attempted to limit the debt issued by LGFVs. This was a result of the booming economy and infrastructure spending that fueled a boom in economic growth. However, this led to many vanity and ill-advised projects. The current effort to resolve this issue is the most concerted up to now.
After the coronavirus outbreak, the local governments’ spending models became unsustainable. Meanwhile, the collapse of land sales that many regions relied on for revenue led to a decline in the financial health of China.
But concerns still remain about how to solve the trillion-dollar problem at a moment when China’s economy has slowed.
The world’s second largest economy is experiencing deflationary risk, as consumer prices in July fell for the first month since early 2021.
The person who works for the finance ministry stated that “Debt Swap Programmes won’t solve the root problem, as local governments with high debt levels may still struggle to pay off their debts in the future.” “Much lower future economic growth undermines fiscal revenue which is a key source of debt repayment.”
Ivan Chung said, “It’s the classic chicken-and-egg problem,” said Ivan Chung. He is managing director at Moody’s Investors Services. How can you repay debt without growth?
Requests for comments were not answered by the state council, People’s Bank of China (PBC), Ministry of Finance, or China Securities Regulatory Commission.