China’s debt-ridden local governments face rising pressure, fallout from property crisis could be crushing

Possible contagion effects of local government defaults could create a systemic crisis with far-reaching implications for China’s economy
‘China model’ of prioritising infrastructure investment to boost economic growth only works because central government is lender of last resort for local governments, economist says

China's economic recovery

Amanda Lee

Published: 10:00pm, 17 Oct 2023

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Defaults among China’s private developers could exacerbate local-level government debt risks, analysts say amid growing concerns over contagion from the real estate sector’s fallout on the economy.

Country Garden, China’s biggest developer, has been struggling to meet its debt repayments. The Guangdong-based real estate company warned last week that it would not be able to service all of its offshore borrowings.

Failure to pay a US$15 million coupon payment on Tuesday by the Chinese developer could trigger cross defaults in its other bonds.

Japanese investment bank Nomura estimated that growth of local government land-sale revenues contracted 19.6 per cent, year on year, between January and August, compared with a slump of 23.3 per cent over the same period in 2022 – a reflection of hard times for local government coffers.

‘Somebody has to eat the cost’: China’s monumental local debt challenge mounts

As such, some local governments are facing increasing debt-repayment pressure after years of hefty spending on low-return infrastructure projects.

The Politburo, the centre of power within the Communist Party, said in July that there would be a “comprehensive” plan to resolve local government debt risks, but no details of the debt-resolution plan have been officially announced.

A number of policy advisers to Beijing have been urging the central government to bail out indebted local governments, pointing to how a prolonged property market downturn could further weaken finances at local governments, which play a critical role in supporting the national economy.

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US rating agency Moody’s Investors Service estimated that, since September, a total of 17 provincial governments have announced the combined issuance of more than 700 billion yuan (US$96 billion) worth of special refinancing bonds to repay debts from local government financing vehicles (LGFVs) – platforms created to aid off-budget financing.

“If Country Garden collapses, it may also put other large private developers in danger,” Zhang Ming, deputy director of the Institute of Finance at the Chinese Academy of Social Sciences (CASS), said last month at a seminar arranged by Peking University.

“If developers continue to fail one after another, [the scale of] local government debt will definitely continue to expand.”

Xu Gao, chief economist at Bank of China International, said that the “China model” of prioritising infrastructure investment to boost growth is successful only because the central government is always going to be the lender of last resort for local governments.

China to discuss advancing 2024 bond quota to aid ailing local authorities

“That’s why local government debt became a big problem as the real estate industry fell into a vicious cycle for the past two years,” Xu said in a blog post published on the China Chief Economist Forum website on October 8.

“In other words, if one local government defaults, it would bring about a systemic crisis and trigger a market sell-off of the debts of various local governments, and even the central government’s,” Xu warned, adding that local government debts are also debts of the central government.

The International Monetary Fund (IMF) said last week in the October update of its World Economic Outlook that China’s economy needs to pivot away from a credit-driven real estate model of growth.

“Restoring confidence requires promptly restructuring struggling property developers, preserving financial stability, and addressing the strains in local public finance,” the IMF said.