China’s central government likely to pitch in as localities attempt to untangle debt knots

Local governments appear out of tools to handle tremendous debt burdens on their own, so central authorities are expected to take hands-on role
Fiscal expansion, central bank financing, special bonds all mentioned as possible levers for driving growth through infrastructure spending

China economy

Amanda Lee

Published: 7:00am, 11 Jan 2024

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China’s central government is likely to take on more responsibility for public infrastructure spending to steady economic growth, policy advisers said, as the property market has yet to stabilise and many regions continue to grapple with debt.

After years of borrowing, the ledgers of many of China’s local governments are deep in the minus column thanks to a sluggish economy and a downturn in real estate.

The International Monetary Fund estimated in a report last year the total debt for China’s local government financing vehicles (LGFVs) had swollen to a record 66 trillion yuan (US$9.8 trillion). Over half of the debt cannot be serviced by current earnings alone, the financial agency said, if average LGFV funding costs are more than 3 per cent.

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LGFVs are hybrid entities that are both public and corporate and were created to skirt restrictions on local government borrowing. They have proliferated since the global financial crisis in 2008.

Wang Yiming, central bank adviser and former vice-president of the Development Research Centre of the State Council, said that China’s growth model, based on debt-fuelled investment and land sales, has become difficult to sustain.

Wang estimated that over 10 per cent of LGFV debt is channelled into new projects, with the rest used to repay the principal and interest on existing debt. Going forward, Wang said, fiscal policy at the central government level will have to play a major role in buttressing the economy.

We cannot rule out the resumption of monetary tools

Zhang Ming, Chinese Academy of Social Sciences

“Debt accumulated in the past has led to huge repayment and risk exposure, and as such it has inhibited the demand for investment [that it has been funding],” Wang said at the 2024 China Bond Market Forum in Beijing on Friday.

Besides fiscal expansion, Zhang Ming, deputy director of the Institute of Finance and Banking at the Chinese Academy of Social Sciences, said the country’s central bank will also be ramping up support.

On January 2, the People’s Bank of China (PBOC) loaned 350 billion yuan (US$49.2 billion) to policy banks through its pledged supplementary lending (PSL) facility in December.

The PBOC, however, did not say how China Development Bank, Export-Import Bank of China and Agricultural Development Bank of China would use the loans.

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“The PSL [loan size] in December was the third-highest in history,” said Zhang, also a speaker at the bond market forum. “I believe the funds may go into the big three constructions in 2024. We cannot rule out the resumption of monetary tools [such as PSL].”

The “big three constructions” is a reference to a trio of major infrastructure projects that function as backbone for the country’s new real estate model: affordable housing, “urban villages” and public facilities with functionality for both ordinary and emergency situations.

The PSL programme, initiated in 2014, is designed to help the central bank better target medium-term lending rates while boosting liquidity to specific sectors by offering low-cost loans to selected banks. China relied heavily on PSL loans to support its shantytown renovation programme from 2015 to 2018.

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While Beijing has been reluctant to bail out financially weaker regions, it has sought to defuse debt risks by allowing local governments to issue special refinancing bonds, estimated to be worth over 1 trillion yuan, which could replace the higher-yield debt issued by LGFVs.

On average, LGFVs pay yearly interest of 6 to 8 per cent, while the new refinancing bonds offer just 3 per cent or below.

China’s leaders at last July’s Politburo meeting pledged to formulate “a basket of plans” to resolve risks stemming from local government debt, although details of those plans have yet to be announced.

Wang Tao, chief China economist at UBS Investment Bank Research, said she expects the central government, which has a much lower level of debt, to provide more explicit aid. This could mean China’s budget deficit target will be set at 3.5-3.8 per cent of gross domestic product, Wang said.

In addition to the 1 trillion yuan in special treasury bonds from 2023, China may sell another trillion in 2024, Wang estimated, adding local governments may be allocated a total of 4 trillion yuan in special purpose bonds for infrastructure investment.

“We also expect continued restructuring for local government debt – including extending loan duration and lowering interest rates, as well as issuing another 2 to 3 trillion yuan in bond swaps to help ease LGFV payment issues,” Wang said.