China’s Local Debt Problem: Managable or Not?
China’s local government debt has been a topic of concern for a while now. It has been estimated by Goldman Sachs that the country’s municipal debt amounts to around 156 trillion yuan. While some of this debt is held on balance sheets, the remaining debt is held off balance sheets via financing vehicles known as Local Government Financing Vehicles (LGFV). This has led to concerns about the Chinese economy, as declining local government revenue has led to a shoddy 2022 from local government revenue. However, according to China, there is no local debt problem.
What China Says
In response to worries over local government finances, China has stated that the debt is manageable. As per Bloomberg, Xinhua News Agency came out with a report on Monday saying that the public finances of China are sound and that there are enough financial resources to prevent risks from spreading. China has tried to convince investors that there is no need to worry about possible defaults. However, some areas are exposed to high risks and severe pressure on principal and interest payments. Therefore, Beijing has urged local authorities to avoid any emerging systemic risks.
The Statistical Analysis
According to Société Générale, the broad revenues of China’s local governments have seen a downfall of nearly 11% in the recent past. Additionally, the revenue obtained by funds, primarily land revenue, has declined by 21%. Some provinces like Tianjin, Jilin, Heilongjiang, and Liaoning have experienced a marked drop in revenues. Meanwhile, overheads have increased by around 3%. As a result, China’s local government deficit increased to 12.2%, i.e., RMB 14.8 trillion, which is 2 percentage points above the pre-pandemic average from 2015-19.
A recent Goldman Sachs report threw light on the debt risk of local administrations and the possible solutions that can be implemented to avoid financial catastrophe. The report suggests that using state-owned enterprise (SOE) stock and earnings, as well as unused assets, can help ease redemption pressures in the short term. Additionally, it also suggests that policy banks and large commercial banks could play a critical role in resolving the crisis. However, a possible default of LGFV bonds could cause a downside risk to investment outlook via crowding-out effects on fiscal policy and credit supply.
What Happens Next?
According to Wéí Yáó and Míchéllé Lám from SocGen, what will happen next depends on how the central government perceives the scenario. The stress of China’s public debt is almost on the verge of breaking point, and this, along with last year’s housing crash, has made things worse. As a result, the possibility of defaulting on LGFV obligations has increased. However, how the central government will respond to these scenarios depends entirely on their discretion.
A Goldman Sachs report suggests debt restructuring and deferral of payments as the solution to China’s local debt crisis. It proposes that China wouldn’t just sit back and allow its municipalities to fail. However, this playbook is getting harder to implement as the stress of local government deficits is mounting. The government will now have to start implementing restructuring measures that become more visible and expand at a greater scale over the next few years.
Possible Consequences
The long-term costs of deferring debt repayment could result in deflation. Keeping zombie LGFVs alive will result in locking up more financial resources, intensifying the problem of capital misallocation and undermining productivity. Banks and the financial system would have less capacity to support productive areas. Additionally, local governments will have fewer resources to improve public services or provide social assistance. Slower income growth would mean deteriorating aggregate demand, making it harder to support unproductive activity. The longer the restructuring takes, the more significant the downward spirals may become, leading to more entrenched deflation. With its construction growth engine and growing deflation, China’s trend growth rate could potentially fall to around 3-3.5% in both real and nominal terms, down from 7% and 10% the previous decade.
The Bottom Line
The question remains: is there or isn’t there a local debt problem in China? While China is convinced that there isn’t a problem, experts beg to differ. The country’s local debt has been piling up, and the government has attempted to keep the debt crisis under control. As of now, there doesn’t seem to be a clear solution. However, with the government’s continually growing intervention and increased use of restructuring measures, there may be light at the end of the tunnel. It remains to be seen how China’s economy will fare in the long run and what impact it will have on the global macroeconomy.
The Unique Insights
While it is essential to look at the numbers and try to figure out what moves China will make next, some other factors come into play when solving the local debt crisis. The first factor is that China is highly centralized. This means that the government has more control over decisions than in other countries. Additionally, China is a single-party state, which means the Chinese Communist Party (CCP) reigns supreme. The CCP is more focused on maintaining its hold over the country and will do everything it can to avoid upsetting the status quo.
As the country’s government becomes more interventionist due to the local debt crisis, its people seem to be growing more disgruntled. This is evident in the rise of the middle class, which has been growing rapidly for some years now. With the middle class growing, they have started demanding more freedom and accountability from their government. If the government doesn’t become more transparent, it could risk losing face.
Another factor is the growing climate change concerns. Pollution has been a severe problem in some regions of China, and the government has been trying to counter this by investing in greener energy alternatives. This is draining resources away from sectors that require development, including the fact that it could pose a threat to the debt repayment.
Conclusion
In conclusion, while China says there’s no local debt problem, several reports suggest otherwise. However, with the government intervening and employing restructuring measures, there may be a way out. The long-term consequences of this intervention could be enormous, leading to increased deflation and a potentially significant decline in trend growth rate. Additionally, the Chinese government is highly centralized and currently facing pressure from the rise of a middle class, which is demanding a transparent democracy. Lastly, climate change is posing an additional challenge that could affect debt repayment capabilities.
—————————————————-
| Article | Link |
|---|---|
| UK Artful Impressions | Premiere Etsy Store |
| Sponsored Content | View |
| 90’s Rock Band Review | View |
| Ted Lasso’s MacBook Guide | View |
| Nature’s Secret to More Energy | View |
| Ancient Recipe for Weight Loss | View |
| MacBook Air i3 vs i5 | View |
| You Need a VPN in 2023 – Liberty Shield | View |
Reassuringly, if you didn’t know China had a local debt problem until you read the title of this article, China says it doesn’t have a local debt problem.
Via Bloomberg:
China said local government debt is manageable and authorities have sufficient financial resources to avoid the spread of risks, trying to allay investors’ fears of possible defaults.
The official Xinhua News Agency released a report on Monday in response to recent concerns over local government finances. He quoted an unidentified Finance Ministry official as saying public finances are generally sound and urged local authorities to meet their debts.
The current challenge is that “the distribution of local government debt is lopsided, with some regions exposed to relatively high risks and under severe pressure on principal and interest payments,” the official said in the Xinhua report.
Beijing urged local authorities to “maintain the bottom line that no systemic risk will arise,” the official said.
The last paragraph is interesting phrasing.
So what’s the problem that’s not a problem?
In short, China is laden with municipal debts – some 156 trillion yuan according to Goldman Sachs, much of it held off balance sheets through financing vehicles (Local Government Financing Vehicles/”LGFV”) favored by local government – and has had a shoddy 2022 from local government revenue. This led to a couple of close calls. For Société Générale:
Their broad revenues (general and funds combined) were down 11%. Within this, the fund’s revenue, which consists primarily of land revenues, decreased by 21%. Some provinces recorded particularly marked declines, such as Tianjin (-62%), Jilin (-61%), Heilongjiang (-59%) and Liaoning (-56%). Meanwhile, overhead still increased by 3%. As a result, the large local government deficit increased from 10.1% of GDP (or RMB 11.7 trillion) in 2021 to 12.2% (or RMB 14.8 trillion), 2 percentage points above the pre-pandemic average (2015-19), requiring more direct transfers from central government to close the gap.
A Goldman note released last week answered some key questions:
What has led to the current LGFV debt repayment stresses in provinces such as Guizhou and Yunnan? Declining local government revenues and the intensifying LGFV liquidity shortage in recent years have exacerbated the difficulties associated with repaying LGFV debt in the most vulnerable provinces.
What are the possible solutions to the debt risk of local administrations? In the near term, we could see more debt swaps and debt restructuring/extensions to defuse impending risk events. Using SOE stock/earnings and unused assets can also help ease redemption pressures in the short term. Policy banks and large commercial banks could play a bigger role in this process.
How would a potential default of a LGFV bond affect the Chinese economy and financial markets? It could pose a downside risk to our investment outlook through crowding-out effects on fiscal policy and credit supply. Policy makers will try to prevent bond defaults this year due to weak sentiment and uneven economic recovery, but we expect increased risks, especially for less developed inland regions.
SocGen’s Wéí Yáó and Míchéllé Lám say what happens next depends… basically on the politburo:
The zero-COVID shock and last year’s housing crash appear to have brought the implied stress of China’s public debt close to breaking point. The situation has hardly improved this year and other signs suggest that the default risk of LGFV bonds is higher than ever. However, whether or how many outright defaults on LGFV obligations will occur depends on the central government’s judgment of the likelihood that such defaults trigger systemic financial risk.
Apparent exposure varies quite widely, when self-funding rates and the unit’s remaining capacity to raise funds through local government bonds (LGBs). Charts here from Goldman, then SocGen:
The solution, says Goldman, lies in debt restructuring and deferral of payments (what did you expect? They would hardly have called for regime change, this is not JP Morgan). Basically, oddly enough, Beijing probably won’t just sit back and allow its municipalities to blow up.
SocGen:
The government has implemented a playbook, consisting of both soft (debt extension) and hard (debt cancellation) restructuring measures – the former being more common than the latter. The deleveraging process will need to accelerate, become more visible and expand in scale over the next few years.
This playbook is getting harder to implement, however, as the stress mounts. But this is China, so there will be a solution. The following, calculates SocGen, is:
— Banks lent to provide increased lending capacity
— Interest rates are being pushed down
and possibly:
— Local austerity measures
— Sales of state property
— Lean even more on the banks
— Tap other state institutions to hide debt losses
With a combination of the above, China will get its way, analysts conclude, but the long-term costs could be enormous. Yao and Lam (their emphasis):
[T]there may be a heavy cost to slow restructuring here: deflation. Keeping zombie LGFVs alive requires locking up even more financial resources, intensifying the problem of capital misallocation and undermining productivity. Banks and the broader financial system would have less capacity to support productive areas. Local governments would have fewer resources to improve public services and social assistance. Slower income growth would mean a weakening of aggregate demand, which would make it more difficult to sustain unproductive activity. The longer the debt restructuring takes, the longer such downward spirals could last, and the more entrenched deflation could become. After losing its construction growth engine and plunging into deflation, China’s trend growth rate could fall to 3-3.5% over the next decade in both real and nominal terms, down from 7% and 10% of the last decade.
In short, Japanization with Chinese characteristics, with some obviously huge implications for the global macroeconomy. But as mentioned, Beijing says there’s nothing to worry about, so take it easy.
https://www.ft.com/content/df485275-9c08-42bf-971a-6f76bd53b1b7
—————————————————-