Why LGFV debt is a growing risk for China’s economy
CRACKS are showing in a pillar of China’s debt market: local-government financing vehicles (LGFVs).
Created to fund such things as roads, airports and power infrastructure, they rarely generate enough returns to cover their obligations. That means most rely on injections of municipal funds to stay solvent.
With many local authorities facing cash-flow problems due to a real estate crisis, there are growing concerns about this US$9 trillion debt market – prompting the government to take steps to effectively bail out weaker issuers and avert a credit crunch.
How do LGFVs work?
LGFVs were originally established to skirt around a ban on municipal authorities borrowing from banks or selling bonds directly in the market.
The money they raise is spent directly on things like infrastructure and state welfare projects that can take a long time to complete and often generate low returns. While LGFVs are categorised as corporate debt, investors generally assume that local governments are held accountable for them.
BT in your inbox
Start and end each day with the latest news stories and analyses delivered straight to your inbox.
How did they become so important?
LGFVs have been central to government efforts to ensure China’s infrastructure and public services expand fast enough to sustain outsize economic growth.
They took off after the 2008 financial crisis, when the government undertook a 4 trillion yuan (S$763 billion) national stimulus plan, and have grown rapidly ever since.
How significant are they to China’s economy?
The International Monetary Fund estimated that LGFV debts nearly doubled over the past five years to about 66 trillion yuan (S$12.2 trillion) – equivalent to more than half of China’s annual economic output.
LGFVs had about 13.5 trillion yuan of outstanding onshore bonds at the end of 2022, according to data from S&P Global Ratings – representing about 40 per cent of China’s non-financial corporate bond market.
All types of financial institutions have exposure to them: commercial banks via their wealth management units, insurers, mutual funds, securities companies and hedge funds.
The overwhelming majority of their investors are local as foreigners consider LGFVs to be opaque and hard to analyse.
How did they become a major risk?
China’s property slump dealt a blow to local governments by depleting their income from land sales. That, combined with a jump in public spending in response to the pandemic, left a majority of regional governments facing a serious funding squeeze.
Half of cities experienced difficulty in managing debt interest payments last year, Rhodium Group said.
Meanwhile, LGFVs were paid average government subsidies of 392 million yuan in 2022, the most in nine years, according to a report from China International Capital Corp.
Has any LGFV defaulted?
No. Even those local governments that are struggling the most appear to be prioritising timely bond payments, given the potentially catastrophic signal it would send if they were unable to pay their way.
But some LGFVs have been making last-minute payments, indicating debt-servicing difficulties.
What is the government doing about it?
In a small but symbolically significant step, China will allow provincial-level governments to raise about 1 trillion yuan via bond sales to repay the debt of LGFVs and other off-balance sheet issuers, Bloomberg News reported in August.
The programme will in effect bail out weaker issuers, shifting the debt burden to provincial governments instead. China’s biggest state banks also have started providing relief, Bloomberg News reported earlier.
Banks including Industrial & Commercial Bank of China and China Construction Bank Corp. were said to be offering loans that mature in 25 years, instead of the prevailing 10-year tenor for most corporate lending, to qualified LGFVs with high creditworthiness.
Some came with temporary interest relief. Past experience shows a missed payment could trigger a surge in perceived risk that would inflate borrowing costs to unaffordable levels for some state entities and state-linked companies.
However, a sector bailout appears unlikely as the central government is trying to discourage reckless risk-taking driven by the assumption that the state will always come to the rescue when things go wrong.
What are the other risks beside a default?
The concern is that many local financing authorities are reaching a point where they will be forced to rein in their borrowing – potentially stanching the flood of cash that has been a steady source of stimulus for China’s economy.
If that happens, the timing could be unfortunate, with investors already worried that the country’s recovery from pandemic restrictions has lost momentum. BLOOMBERG
Share with us your feedback on BT's products and services
