“I have lost all confidence to invest in the domestic market, whether via private wealth products or funds associated with local debt,” said Liu, who took part in a lawsuit against the funds for selling fraudulent financial assets, but has yet to recoup his losses.

China finds dozens of local governments misusing funds in debt crackdown

Across China, a growing financial burden on local governments is pushing many to gamble with dangerous debt products aimed at retail investors, which are reigniting concerns about financial risk that Beijing has been at pains to keep under control.

Local government revenue from land sales has tumbled this year due to a slump in the property market, while many regions have had to cut taxes to rescue their economies from Covid-19 outbreaks in recent months.

Direct marketing of debt instruments to retail investors on social media platforms such as WeChat is one unconventional approach being used by local authorities.

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China’s economy grew faster than expected in first quarter, despite “significant challenges”

China’s economy grew faster than expected in first quarter, despite “significant challenges”

Disclosure requirements for LGFVs, which were created to skirt restrictions on direct fundraising by local authorities, are weak. And supervision over the use of funds has been inconsistent. In many cases, this has led to wasteful spending and a misuse of public money. But that has not stopped them proliferating over the past 14 years.

In Shouguang, a city in the eastern province of Shandong, investors can book returns of 10.2 per cent over two years for a debt contract backed by a plot of land owned by the local government, according to Yizichan.com, a platform that markets local debt products.

In Shandong’s Weifang Binhai, returns of 8.8 per cent per annum are being offered as part of a scheme to raise money for a “hi-tech biochemistry industrial estate” in the district.

‘I have nothing but loans’: China’s economic rut shakes middle-class dreams

Returns are much higher than those offered by listed bonds. Weifang Binhai, for example, is offering 5 per cent over a year for its bonds, according to Chinese data provider Wind.

Although the products had been approved by local authorities, they still carry risk, according to a marketing manager at a company selling LGFV debt via WeChat.

“Right now, the central government is not doing much to promote consumption, it’s keeping a tight lid on the flow of money,” said the manager, who gave only her surname as Han.

“If it doesn’t crack down on these products, it’s going to do better than the trust sector,” the person added, referring to the asset-management industry that sells high-yield financial products to wealthy Chinese.

“100,000 yuan at these rates is very favourable among ordinary people whose cash is just sitting at a bank earning just 1.5 per cent a year.”

Since June last year, a total of 165 LGFV debt products have been sold online, according to estimates by YY Rating based on publicly available marketing information.

The products were debt contracts from 15 provinces – though mainly from Shandong, Sichuan and Henan – with a total of 270.8 billion yuan (US$40.4 billion) raised as of June 2022.

Local authorities also bundle LGFV debt into trust products, but the minimum investment is typically between 300,000 yuan and 1 million yuan. Given current fundraising difficulties, local governments with poor credit profiles are likely to use both means, according to a Beijing-based trust manager surnamed Huang.

“It’s not easy for those with weak credit records to borrow,” he said. “But 10 per cent a year is really high; I would be wary of the risk. Usually, trust products do not offer this much. You may not get your money back at all at this rate.”

Is China’s local government debt a concern and what role do LGFVs play?

Alice Chen, a customer manager at a Shenzhen-based private investment fund, expressed concern that LGFV debt products may turn bad if there are changes in local government management. Because investments are often tied to certain projects, in the case of a default, new management may not offer a guarantee.

“At best, they can be described only as private funds of some platform companies under the local government,” said Chen, who added that her clients did not have the risk appetite for LGFV debt.

Since the beginning of the year, China has also put dozens of senior LGFV executives under investigation. The platforms are being probed for inappropriate on-lending, providing debt guarantees for private enterprises, as well as alleged bribery and profiteering.

While a target of the national anti-corruption campaign, analysts believe LGFV debt is likely to grow as the central government pushes for more state-led infrastructure investment to ensure annual growth of “around 5.5 per cent”.

“We think LGFVs’ onshore issuance is likely to stay strong in the second half of this year,” said Zhang Shuncheng, associate director for corporate research at Fitch Ratings.

“The amount of maturing bonds will rise slightly, year on year, in the second half while growth in infrastructure investment may hit the highest level since 2017 to support economic growth this year.”

Yao Yang, an economist and professor with Peking University’s National School of Development, said local governments could issue up to 5 trillion yuan worth of special purpose bonds this year if Beijing gives the green light to bring forward the 2023 quota.

China’s US$8.2 trillion hidden local government debt now over half of GDP

“But we know that this quota is not going to be enough … there are fewer and fewer good projects,” Yao said in June.

Based on provincial planning documents, local governments need to raise 6 trillion yuan (US$894 billion) per year over the next five years to meet infrastructure needs, Yao said.

“I think infrastructure this year may be quite effective [to lift growth], but let’s not get our hopes up,” he said.

China’s overall debt to gross domestic product (GDP) in the first quarter of 2022 rose 4.4 percentage points to 268.2 per cent from the end of 2021, with Covid-19 remaining the biggest uncertainty, according to a quarterly report in May from the National Institution for Finance and Development, a Beijing-based think tank.

“Judging from the current state of the economy, the negative pressure from external shocks is still relatively large, and the economic growth rate in the second quarter is likely to be lower than expected,” the think tank said. “If the annual economic growth rate is less than 5 per cent, the debt-to-GDP leverage ratio may rise by nearly 10 percentage points.”

Sarah Xu, assistant vice-president and an analyst at Moody’s Investors Service, said that because infrastructure development has been highlighted as a key driver of the economy this year, investors might still put money into LGFV debt.

“Investors may still see the whole LGFV sector as important to both the central government and local governments – and that it is still safe,” she said.

Xu said lower-tier governments at the county or district level will continue looking for different ways to raise money.

“There is also uncertainty over whether provincial governments will allocate sufficient bonds or funding to those lower-tier governments,” Xu said.