According to sources familiar with the matter, the Chinese government has instructed state-owned banks to extend the maturity of current local government debt by providing longer-term loans at reduced interest rates. This directive aligns with Beijing’s ongoing endeavors to mitigate debt-related vulnerabilities within an economy experiencing a slowdown.
According to economists, municipalities burdened with debt pose a significant threat to the second-largest economy in the world and its financial stability. This concern arises in light of a worsening property crisis, prolonged over-investment in infrastructure, and substantial expenditures incurred to mitigate the impact of the COVID-19 pandemic.
The aggregate debt of local government entities in China escalated to 92 trillion yuan ($12.58 trillion) in 2022, representing a substantial proportion of 76% of the nation’s gross domestic product. This figure demonstrates a notable increase from the recorded 62.2% in 2019.
A component of the aforementioned entails the issuance of debt by municipal funding vehicles (LGFVs), which cities employ to procure funds for infrastructure initiatives, frequently in response to the central government’s promptings during periods necessitating economic expansion. The depletion of financial resources may pose challenges for Beijing in its efforts to stimulate a faltering economic revival.
The available sources need more specific details regarding the extent to which the debt will undergo restructuring.
According to a source, to mitigate potential significant losses arising from restructuring the debt process, it is recommended that the interest rates on the fell-over loans not drop below the prevailing rates of China’s Treasury bonds. Additionally, the source suggests that loan terms should be limited to a maximum duration of 10 years. The current yield of China’s benchmark 10-year government bond is approximately 2.7%, whereas the standard one-year loan prime rate is 3.45%.
The sources above expressed their decision to withhold identification, citing the confidential nature of the policies in question.
According to an anonymous banker, the interest rates associated with loans obtained by LGFVs typically range around 4%. However, it is worth noting that these borrowing costs may escalate to approximately 5% to 8% in specific regions and circumstances. The banker’s request for anonymity stems from a lack of authorization to engage with the media.
According to the individual, implementing a comprehensive loan extension and reducing interest rates would significantly impact the operational capabilities of financial institutions.
In light of the escalating regional fiscal predicament, the central government of China has adopted a prudent approach to addressing debt concerns to mitigate potential moral hazards. By refraining from consistently intervening to salvage local governments or state-owned enterprises, Beijing intends to discourage investors from assuming unwarranted risks.
The escalating property crisis in China has contributed to the mounting strain on municipalities, as developers cannot procure additional land, which has conventionally served as a significant avenue for local revenue generation. Since the debt crisis in the sector in the middle of 2021, a substantial number of companies, comprising approximately 40% of Chinese home sales, have encountered defaults. It is noteworthy that the majority of these entities are private developers.
The People’s Bank of China (PBOC) and the National Financial Regulatory Administration have yet to respond to Reuters’ request for comments.
The Politburo of China, a prominent decision-making entity within the ruling Communist Party, stated in late July its intention to disclose a range of measures to mitigate the risks associated with local government debt. However, as of now, comprehensive plans have yet to be officially released.
According to a recent note by analysts at ANZ Research, the gradual repayment of the entire local government debt over 20 years would necessitate annual payments amounting to 6.5 trillion yuan. According to their statement, the figure above surpasses China’s projected yearly nominal GDP growth for the upcoming decade.
The central bank intends to prioritize resolving debt risks in 12 regions identified as “high risk.” These regions include Tianjin city, Guizhou province, and Guangxi province. The central bank’s focus will primarily be addressing the challenges posed by publicly traded bonds and non-standard debt products due within the current and upcoming fiscal years, as per reliable sources.
According to sources, there is an encouragement for banks to engage in the issuance of fresh loans to Local Government Financing Vehicles (LGFVs) to repay bonds and non-standard debt.
Chinese investors are inclined to acquire bonds issued by Local Government Financing Vehicles (LGFVs), even those emanating from the most precarious entities. This trend can be attributed to Beijing’s concerted efforts to mitigate the perils associated with local debt, thereby fostering investor confidence in an implicit government guarantee.
According to a study note by UBS, local government financing vehicles (LGFVs) are anticipated to encounter substantial bond maturity pressure during 2023 and the initial half of 2024. According to the note, a significant amount of LGFV bonds, totaling 2.1 trillion yuan, reached maturity during the initial half of 2023. Additionally, an additional 1.75 trillion yuan is expected to mature in the latter half of this year, followed by 1.69 trillion yuan in the first half of 2024. This cumulative maturity pressure represents an unprecedented level in history.
Furthermore, it has been reported by two sources that the People’s Bank of China (PBOC) intends to establish an emergency mechanism in collaboration with banks. This mechanism will facilitate the provision of loans to Local Government Financing Vehicles (LGFVs) to address any potential short-term liquidity challenges. According to an additional source, it is expected that the LGFVs will be required to fulfill the repayment obligations associated with the loans within a two-year timeframe.
The emergency liquidity tool of the central bank was initially reported by the financial news outlet Caixin in August.
Within the 12 regions deemed to possess a heightened level of risk, certain local governing bodies will be required to commit or transfer a portion of their ownership interests in local state-owned enterprises to financial institutions. This exchange will serve as a means for said banks to extend assistance in the form of loan rollovers, as disclosed by the second source.
In the previous fiscal year, a financing entity affiliated with the Chinese government operating in the southwestern province of Guizhou facilitated loan disbursements amounting to $2.3 billion. These loans were structured with a maturity period spanning two decades, accompanied by interest rates ranging from 3% to 4.5% per annum.