China’s ‘problematic’ local debt in the spotlight as it begins scaling back coronavirus stimulus
- With economic momentum stabilising in China, local government debt and corporate bond defaults are emerging as the prime financial risks
- But experts say Beijing faces a challenge in balancing debt reduction in cash-strapped regions while maintaining post-coronavirus growth
China’s continued strong recovery from the coronavirus pandemic in the first quarter is prompting Beijing to begin tackling financial vulnerabilities, including introducing tighter borrowing rules for debt-ridden provinces and curbing bank credit for the red-hot property sector.
Clearing debt together with helping businesses recover and prepare for international uncertainty are expected to be high on the agenda when China’s elite policymaking body, the 25-member Politburo, gathers for its upcoming meeting, analysts said at an economic conference in Beijing this week.
Such policy fine-tuning will be closely watched, as the world’s second largest economy has already started scaling back trillions of yuan worth of stimulus launched last year to fight the pandemic and its associated economic shock.
The local debt issues, which reflect the resource-funded growth model, are problematic
Wu Xiaoqiu, a professor of finance at Renmin University of China, warned local government debt and corporate bond defaults are the prime financial risks as China is now gearing down towards medium-speed growth.
“Local debt issues, which reflect the resource-funded growth model, are problematic,” he said at a seminar hosted by China Chengxin International on Wednesday.
China’s State Council, the country’s cabinet, vowed last month to keep the nation’s macro leverage ratio – often measured in terms of debt to gross domestic product (GDP) – basically stable. It also said reducing government debt would be a priority this year.
Fears of a debt bubble have already put the brakes on new developments, particularly those with high liabilities. Local government bond issuance, which is used mainly to fund infrastructure projects, rose 47.7 per cent year on year to 6.44 trillion yuan (US$993 billion) in 2020.
China debt: how big is it and who owns it?
Earlier this month, the provincial government of Shaanxi in western China said it had suspended construction on an intercity high-speed railway network, which is estimated to be worth 50 billion yuan, after “considering fundraising and risk prevention”.
Shaanxi reported outstanding debt of 743.3 billion yuan by the end of 2020, ranking No 15 among the country’s 31 provincial-level jurisdictions in terms of indebtedness, according to China Local Government Bond Market Access, a newly launched government website to track public debt.
The figure represents about 28.4 per cent of its GDP, but is slightly larger than last year’s combined total of local tax revenue, central government transfers and land sales, according to calculations by the South China Morning Post.
Zhao Quanhou, a senior researcher with the Chinese Academy of Fiscal Sciences, an affiliate of the finance ministry, said Beijing had vowed to settle implicit debt – which is widely estimated to be much larger than the official figure of 26.2 trillion yuan – by 2027, citing an internal speech made by finance minister Liu Kun.
We must lower the [local] government ratio as much as we can, on the condition of not derailing growth for this year
“It has become a political requirement,” he said at the seminar. “We must lower the [local] government ratio as much as we can, so as not to derail economic growth this year.”
Local government financing vehicles (LGFVs) could be among the primary targets for debt reduction. Although invented to raise funds via off-balance sheet borrowing, the debt is considered a local government liability.
A budget management reform circular released by the State Council in early April said LGFVs should be restructured or liquidated.
China is not the only country witnessing its public debt balloon following the pandemic. The United States and the euro zone have also undertaken unprecedented loosenings of their financial conditions to fight the economic effects of the virus.
China’s debt-laden local governments urged not to ‘blindly expand’ post-coronavirus infrastructure projects
However, many economists and policy advisers have warned increasing debt in China could weigh on the recoveries of some financially vulnerable regions.
Interest payments on bonds made by local governments rose 21.3 per cent to 796.3 billion yuan in 2020, and 27.4 per cent to 169 billion yuan in the first quarter of this year.
Moreover, in many cases new bonds are being used to repay old debt. China issued 477.1 billion yuan of local government debt in March, 440.7 billion yuan of which was used to repay old loans.
Zhang Ming, deputy director of the institute of finance and banking at Chinese Academy of Social Sciences, said Beijing needs to maintain moderately expansionary macro policies to boost growth and keep interest rates low, preventing the debt situation from worsening.
In the long run, the central government should consider issuing special Treasury bonds in place of local debt and state-owned commercial banks should also participate in debt restructuring, he added.
