China Economy

Provincial debt won't be threat to the economy, says Standard & Poor's

Ratings agency says the mainland economy is expected to expand in the next few years at a rate that can support government liabilities

PUBLISHED : Monday, 10 December, 2012, 12:00am
UPDATED : Monday, 30 May, 2016, 5:01pm


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Local government debt will not pose a systemic risk to the Chinese economy in the next three to five years, according to a director at ratings service Standard & Poor's.

Zhong Liang, of the agency's government and public finance ratings division, said regulatory measures taken by the mainland, including widening direct financing channels in bond markets, were expected to win time for risks to be "assimilated".

Liabilities of local governments and their affiliated financing vehicles swelled from 2.8 trillion yuan (HK$3.48 trillion) in 2009 to 10.7 trillion yuan at the end of 2010, according to the National Audit Office, after huge stimulus funding was poured into the economy during the 2008-09 global financial crisis.

The amount seemed manageable compared with the nearly 40 trillion yuan gross domestic product in 2010, noted analysts, although the rapid growth of local debt raised eyebrows and put governments' solvency under the spotlight.

In many cases, the debt is owed by local government financing vehicles (LGFVs), which borrow on behalf of local governments and then fund infrastructure projects.

LGFV debt was widely regarded as the biggest risk in the economy last year, after the banking regulator said a majority of bank loans to such vehicles had repayment problems and warned defaults might escalate this year and in 2013, when a big part of the loans matured.

"Growth of local government debt has slowed this year under China's tightening measures," Zhong said. "The economy is expected to expand at a pace no slower than 7 per cent annually in the next three to five years, which would provide solid support to the government liabilities."

The mainland's banking regulator constrained banks from advancing new loans to LGFVs this year. But it lifted an outright ban introduced last year and allowed the rollover of existing loans to the financing vehicles, easing the financial pressure felt by local governments.

Meanwhile, Beijing lowered thresholds and encouraged LGFVs from provincial level to county level to raise debt in bond markets this year.

"The LGFVs are raising funds through bond market, trust firms and banks' wealth management products in supplement of bank loans," said Zhong. "Interest rates of LGFV bonds sometimes were bid as high as 7 per cent, partly reflecting the credit risks contained in such bonds."

LGFVs raised more than 550 billion yuan through debt issues in the first three quarters of this year, already exceeding the full-year amount of 425.7 billion yuan last year. Urbanisation and economic expansion would generate demand for infrastructure and utility investment, said Zhong, who expects the LGFV bond market to boom as the mainland government is determined to reduce financing through bank loans.

"The general trend will be raising much more funds through bond markets, although the process may be characterised sometimes by a period of bond issuance boom followed by a moderation," said Zhong.

Local governments are banned from raising debt directly under the budget law, and debt is either issued by LGFVs or de-facto by the finance ministry on behalf of local governments.

Local governments were not expected to be able to issue genuine general obligation bonds in the near future, Zhong said, partly because there was no clear framework to address local government default. There is limited disclosure of revenues and outlays of local governments.

"It would be very difficult to make the government increase the disclosure of this information, considering it is already quite hard to get it to release detailed expenditures in 'three publics' [three types of administrative spending]," Zhong said.