Beijing's decision to allow local governments to defer repayment of bank loans - to avoid the loans being declared non-performing - is widely expected to backfire.
That's because it creates more room for bureaucratic interference and malfeasance.
As debt-ridden local government financing vehicles (LGFVs) - companies established to borrow on behalf of local governments, which cannot borrow on their own - begin applying for the one-off extensions to loans they used to fund infrastructure projects, bankers are increasingly concerned about rising long-term risks.
About 70 per cent of the infrastructure projects funded by such loans are unlikely to generate enough income to repay the debts in full, according to the China Banking Association.
The China Banking Regulatory Commission has allowed some LGFVs to defer repayments if they meet collateral requirements. The move is part of Beijing's efforts to curb growth in bad debts, given that the debt liabilities of local governments total a staggering 10.7 trillion yuan (HK$13 trillion). According to the National Audit Office, the amount of loans extended to LGFVs stands at more than 2.6 trillion yuan.
Non-performing loans can cause banks losses that reduce their equity and make them less solvent.
Beijing has been trying to resolve this financial mess since last year. However, the cash-flow problems of the LGFVs seem to be more serious than they appeared. As a result, LGFVs are desperately seeking to restructure their debts.
According to Bloomberg, since last month 11 government-backed debtors from 55 local authorities have sought an extension to repay liabilities totalling 30.16 billion yuan.
'As the banking regulator allows us to do so, we will follow the directions,' said a senior banker with one of the state-owned banks. 'But the administrative interference is set to exacerbate the problem.'
Three other bankers at state-owned lenders share this view and have cast doubts on the decision to defer loan repayments.
In 2008 and 2009, banks were encouraged to grant loans to LGFVs as part of Beijing's 4 trillion yuan (HK$4.54 trillion) stimulus package to counter the global financial crisis.
Last year, the central government ordered banks to halt loans to LGFVs and took a series of measures to prevent a sharp rise in bad debts.
In October, Beijing - for the first time in 17 years - allowed four local governments (including Shanghai and Guangdong) to directly sell bonds to tackle their LGFVs' cash-flow problems. However, the bond sales did not raise enough money to cover their bad loans.
LGFVs are allowed to defer loan repayments by a year or more, but can only apply once.
'After all, the concept of debt restructuring is a game of face, since it just helps transfer short-term, questionable loans into long-term bad assets,' said Yang Jiannan, a China Construction Bank official. 'Government officials feel comfortable with the tactic, but banks are facing increasing long-term risks.'
Bankers said lenders would most likely approve LGFVs' applications to defer loan repayments.
'It's like a grace period granted to local governments who might want to bet on fiscal revenue surging in the next year or the years ahead,' said Guo Tianyong, professor at the Central University of Finance and Economics. 'They expect a windfall in the future to repay the debts.'