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China is trying to reduce debt among local government financing vehicles (LGFVs), which were created to skirt restrictions on local government borrowing. Photo: AFP

Explainer | China’s hidden debt: how much is it and what is Beijing doing to curb the financial risk?

  • Debt levels among China’s local government financing vehicles (LGFVs) are an issue of growing concern for authorities
  • Beijing has begun tightening bond issuance criteria for LGFVs and ordered local governments to clear existing credit by 2028
Local governments in China are racing to clean up off-balance sheet borrowing as cutting debt is now top of the political agenda for Beijing.
Late last month, the State Council said it would allow Guizhou, one of China’s poorest and most indebted provinces, to delay credit repayments and undergo restructuring, underlining the government’s focus on debt management despite a slowing economy.

In recent years, the central government has stepped up supervision of local government financing vehicles (LGFVs), which were created to skirt restrictions on local government borrowing and have proliferated since the global financial crisis in 2008.

These platforms, opaque in nature, are often used to raise funds for infrastructure spending that does not immediately generate returns, leading to the accumulation of hidden debt in the regional economy.

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Because the main lenders to LGFVs are banks, a large-scale default could trigger contagion in the banking sector.

Since 2015, Beijing has been promoting the transformation of LGFVs from focusing on public welfare into more commercialised entities, effectively reducing the risk to the financial system and chances of a state bailout.

Here are a number of challenges facing Beijing and local governments in their attempts to avert a debt crisis.

How did debt pile up with LGFVs?

The number of LGFVs has grown rapidly since 2008. Guangfa Securities estimates that as of December 2021, there were a total 3,060 LGFVs that sold debt in the public bond market.

A nationwide review by the National Audit Office in 2017 found some local government officials had “incorrect views” about their political achievements and used excessive borrowing to boost their performance.

Some officials did not consider whether they had the means to repay debt before embarking on a project, ignoring financing guidelines, according to the audit report.

Financial institutions were also found to have ignored risk management guidelines, offering funds to local governments based only on their guarantees of repayment, rather than their ability to pay.


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The central government and local governments have never publicly disclosed the scale of off-balance sheet borrowing or which lenders are exposed.

Lu Ting, chief China economist at Nomura, estimates that local government hidden debt, including loans and bonds, hit 45 trillion (US$7 trillion) yuan at the end of 2020, equivalent to 44 per cent of China’s gross domestic product (GDP).

That was more than four times the 9.6 trillion yuan at the end of 2010, which was around 23 per cent of GDP, according to Lu’s estimate.

What is Beijing’s plan to curb LGFV debt?

The Ministry of Finance said in 2018 all hidden debt must be repaid within the next five to 10 years, the first time the central government has laid out a clear deadline.

In 2019, the finance ministry began to roll out a pilot programme to swap hidden debt for on-balance sheet debt at the local level, focusing on regions with weaker economies under high repayment pressure.

Last year it issued more guidelines on the use of proceeds from special purpose bonds, which are funnelled into infrastructure spending, to tackle misuse of funds and embezzlement by local government officials.

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The central government last May began to implement a “four-colour restriction” system based on the leverage level of local governments. Authorities assigned a colour indicating high leverage could see fundraising limitations in capital markets.

“Since last year we have seen party secretaries of local governments required to meet working groups on local government debt management, which brings this item to the highest level of the central and local political agenda,” said Davis Sun, a director at Fitch Ratings.

How effective are the new debt control measures?

Earlier this month, China’s manufacturing hub, Guangdong province, declared it had cleaned up all of its hidden debt ahead of the finance ministry deadline. However, it did not provide any details on how it was achieved.

Analysts believe Guangdong provincial government is likely to have made use of the ministry’s pilot programme to swap some of its hidden debt with bond quota assigned by the ministry. The Guangdong government may have also transferred some funds to cash-strapped smaller counties to help repay outstanding debt.

Guangfa Securities noted in a report last month that Guangdong has already issued 112.1 billion yuan worth of bonds under the finance ministry debt programme.

The research firm also estimated that as of January 20, 27 out of China’s 31 provincial-level municipalities have joined the debt swap programme.

Beijing raised 277 billion yuan, while Liaoning, Chongqing, Tianjin and Xinjiang amassed about 40-50 billion yuan.


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How bad is the debt situation in Guizhou?

The southwestern province, which has a population of more than 38 million and is famous for making the popular liquor Mao-tai, relies on land sales and central government transfers for financing.

As economic growth has wavered, it has turned to the old playbook of infrastructure spending, worsening its debt problem.

The province’s Dushan county admitted “reckless borrowing” after it embarked on a construction spree between 2016-20, which included a number of white elephant projects.

As of 2020, YY Rating estimated Guizhou’s debt to revenue ratio hit 706.56 per cent, the second highest among all provinces.

The province’s LGFVs have defaulted on at least 68 debt products since 2018, the most among China’s provinces, according to Tianfeng Securities’ estimates.

The defaults have hurt Guizhou’s credit record, so its bonds have been shunned by investors.

Last year, it only raised 69.4 billion yuan through bonds sold by LGFVs, down from 2020’s 47.6 billion yuan, according to Guangfa Securities, leaving the southwestern province with a shortfall of 2.3 billion yuan in debt repayments for the year.

Although it is undergoing a government-approved restructuring process, there is still concern over the province’s high default risk, which could affect fundraising in coming months.

“Markets are likely to avoid Guizhou LGFVs bonds for the time being,” said Yin Ruizhe, chief fixed income analyst at China Merchant Securities in a note on January 27.

Is there a future for LGFVs?

Yes. But perhaps not for all local governments. Sichuan, Chongqing, Shaanxi, Shandong, Gansu and Hunan have released documents to accelerate market-oriented transformation of LGFVs.

Transformation of LGFVs into commercially viable operations requires a favourable regional environment, and not all local governments have profitable businesses suitable for developing the platforms, Guangfa Securities said.

Li Yang, former vice-president of Chinese Academy of Social Sciences, who has advised Beijing on local government debt, said transformation of LGFVs is still ongoing and there are other issues such as tax revenue that need to be addressed before regional debt can be sustainable.

Additional reporting by Orange Wang