The Economist - USA (2021-12-18)

TheEconomistDecember18th 2021 Finance&economics 59

LocaldebtinChina

Lurkingdanger

W

henofficialsinthesoutherncity
ofLiuzhoubegana routineauction
ofparcelsoflandinJune,theyfoundfew
takers.Onlyoneoffiveplotsreceiveda bid;
therestwentunsold. Asinmanycities
acrossChina,a downturnintheproperty
markethasmeantlessdemandfortheland
onwhichapartmenttowersarebuilt.
Thatisbadnewsforlocalgovernments,
whichrelyonthesalesforthebulkoftheir
revenues.Itisalsoa troublingsignforthe
holdersofbondsissuedbylocal­govern­
mentfinancingvehicles(lgfvs),thehalf­
public, half­corporate concoctions that
havebecomea cornerstoneofChinesede­
velopment.Cities’land­salerevenuesare
oftenusedtorepaythesebonds.Afterthe
auctionsfloppedinLiuzhou,ratingagen­
ciesdowngradedtwoofthecity’slgfvs on
fearsthatthegovernmentwouldstruggle
toservicetheirdebts.
lgfvs areoneofChina’soddestfinan­
cialinnovations.Inthemid­1990sthecen­
tralgovernmentimplementedbudgetlaws
tostoplocalbureaucratsbuildingupmas­
sivedebts.Inresponse,regionalgovern­
mentscraftedlgfvs asa workaround.The
vehicles,whichnumberinthethousands,
became important drivers of economic

growth,helpingbuildbridges,homesand

roads.TheyalsobecameoneofChina’sbig­

gestkindsofliabilities,buildingupsome

53trnyuan($8.3trn,or52%ofgdp)inon­

shore and offshore debts, according to

Goldman Sachs, abank. Although such

borrowingdoesnotappearonpublicbal­

ance­sheets,localauthoritiesarerespon­

sibleforpayingit back.Therunawaydebts

nowthreatentothrowthefinancialsystem

intoturmoil.

Thecentralgovernmenthasspentyears

tryingtoreformChina’sshadowfinancial

system,butdebtsthatarehiddenoffbal­

ance­sheetshavebeenslowtoshrink.Take

shadowbanking,forinstance.Althoughit

hasdeclinedasa shareofbanking­system

assets,outstandingshadowloansremain

high,at57.6trnyuanattheendofSeptem­

ber. Similarly,a municipal­bondmarket

nowletscitiesandprovincesraisefunds.

Yetlgfvdebtsattheendof 2020 stillex­

ceededoutstandingcentralandlocalgov­

ernmentbondscombined.

Manylgfvs makemeagreearningson

thebridges,roadsandwatersystemsthey

build.Officialsusedtobeabletomakeup

theshortfallwithland­salerevenues,but

thisisbecomingharder.Ina roundofsales

thisyearfor 22 ofChina’sbiggestcities,the

premiumfetchedonparcelswasjust4.7%

above the government’s reserve price,

comparedwith16.7%earlierintheyear,ac­

cordingto EnodoEconomics,aresearch

firm.ThedefaultofEvergrande,a develop­

er with$300bnin liabilities, andwider

malaiseinthepropertyindustrymeansde­

mandforlandcould continuetosuffer.

Newhomepricesfellfora thirdconsecu­

tivemonthinNovember,accordingtofig­

urespublishedonDecember15th.

Nolgfvhasyetdefaultedona bond.

Butmanymarket­watchers,suchasLarry

HuofMacquarie,a bank,believeit isonlya

matteroftime.Thevehicleswillfacere­

paymentsofoffshorebondsof$32.2bnin

2022,upfrom$26.9bnin2021,reckonsNo­

mura,a Japanesebank.Manyofthemissue

short­term debtsimplyto pay offother

maturities.GuangxiLiuzhouDongcheng,

anlgfvthatwasdowngradedbys&p, a rat­

ingagency,inOctober, had25.7bnyuan

($4bn) in short­term maturities, for in­

stance.Anaverageof60%oflgfvbondis­

suancehasgonenottonewgrowth­gener­

atingprojectsbuttowardspayingoffma­

turingdebtsin 2020 and2021.

Manylocalgovernmentsappeartobe

preparingforafinancialstorm.Liuzhou

hasusedanestimated20bnyuaninpublic

funds to make up a capitalshortfall at

Dongtong Investment and Development

Group,a vehiclethatwasdowngradedin

AugustbyFitch,anotherratingagency.An

lgfvinthecityofChongqingdefaultedon

bankers’acceptancebillsinMarch.Subsid­

iariesofaprovincialvehicleinGuangxi

have gone bankrupt. Provincial govern­

mentsinJiangsuandYunnanhaveissued

guidelinescallingforcollapsinglgfvs to

gointoformalbankruptcyinsteadofbeing

hiddenundermoredebt.

Suchreformswillnotcomeeasily.The

value of onshore lgfv bonds stood at

11.9trnyuaninJune,sixtimesthoseissued

bydevelopersanda tenthofChina’son­

shore­bond market (see chart). A slight

shift in sentiment towards the govern­

ment’simplicitguaranteeforlgfvs could

roilmarkets.Thiswashighlightedbythe

cautionaround“DocumentNo.15”,anin­

ternalcircularissuedbythebankingregu­

latorinJuly,whichtoldlenderstocutac­

cess to working­capital loans for some

lgfvs.Ifupheld,thenewrulescouldhave

causedacash crunchforthevehicles—

similartothesqueezethatbroughtdown

Evergrande.Buttheywerequicklyaban­

doned.Lettinglgfvs failisa linethecen­

tralgovernmentisnotyetwillingtocross.

The situation illustrates the market­

distortingpowerofmissedreforms.Many

othersectors,suchaspropertyandnon­

corestate­ownedenterprises,arenolon­

gerseenasbackedbythecentralgovern­

ment.Thefactthattheauthoritiesdidnot

decisivelyendtheirimplicit supportfor

lgfvs earlierthisyearhasledmanyasset

managersinChinatoconsiderthemsafe.

lgfvbondyieldshavefallentowardsthose

ongovernmentbonds.Fundshavepoured

in.“Theyarebecominga haven,”saysMr

Hu.Theyshouldbeanythingbut.n

H ONGKONG
Apropertyslowdownshedslightona hugehidden-debtproblem

Toweringvulnerabilities

Borrowing binge

China

Sources:Wind;Macquarie *To June

12

9

6

3

0

181614122010 21*

Stock of onshore bonds issued by local-

government financing vehicles, yuan trn

Other

Othercorporatebonds

Local-government

financingvehiclebonds

Interbank-creditdeposits

Central-governmentbonds

Local-governmentbonds

Financialbonds

2520151050

Stock of onshore bonds, % of total

June 202