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Beijing is making one of its biggest top-down efforts in years to tackle the debts racked up by local governments in a sign of authorities’ mounting concern over the risk to financial stability as the economy falters.
China’s state council, the country’s cabinet, is sending teams of officials to more than 10 of the country’s financially weakest provinces to scrutinise their books — including the liabilities of opaque off-balance sheet entities — and find ways to cut their debts.
Working groups from the central bank, finance ministry and securities watchdog are involved in the debt resolution effort in those provinces and will report to Premier Li Qiang, two people familiar with the initiative said.
The enormous debts accumulated by China’s provinces have become an urgent problem for policymakers as they try to end the country’s long reliance on a debt-fuelled infrastructure binge to drive economic growth. One Goldman Sachs estimate puts the total local government debt pile at Rmb94tn ($13tn), including liabilities of the off-balance sheet entities known as local government financing vehicles.
A meaningful debt resolution would reshape the regional investment and financing landscape, but would also trigger repricing of locally raised bonds and could affect the shares of regional banks that lent heavily to LGFVs.
While the plans being drawn up could change, the two people said, one of the most important tasks would be to review and categorise LGFVs’ “hidden debt” — money that does not appear on local government’s balance sheets and is often raised off-exchange or through other non-public channels.
Under the initiative, some of this debt could be swapped to official local government debts, while the rest could face restructuring, they said.
A third source close to the finance ministry said among the options was to allow local authorities to use some low-interest special purpose and other bonds to pay off relatively high-interest LGFV debt.
The working groups will also press policy and commercial banks to extend the maturity of loans to LGFVs to ultra-long terms and cut interest rates.
One of the biggest sticking points between central and local governments was who should pay for a clean-up. Beijing wants provinces to sell assets to help repay debt but local officials plead that many assets are illiquid and that the central government must do more to help with rescues.
The groups may keep pushing local authorities to sell assets to pay down their debt and stick to the principle of no direct central government bailouts to avoid moral hazard, the three people said.
The plans have been drawn up by China’s leading decision-making body politburo, chaired by President Xi Jinping, which vowed in July that it would “formulate and implement a package of plans” to help de-risk local government debt.
Since 2015 China has undertaken repeated attempts to curb debt issuance by LGFVs, which ballooned as infrastructure and property spending fuelled booming economic growth but resulted in many ill-advised and vanity projects. However the current effort is one of the most concerted to date to resolve the issue.
Local governments’ spending model became increasingly unsustainable after the coronavirus pandemic drastically pushed up their costs, while a collapse of land sales on which many relied for revenue has triggered a deterioration in the broader financial health of China’s regions.
However, concerns remain over how the trillion-dollar debt problem can be solved at a time when China’s economic growth has slowed.
This year’s target of 5 per cent growth is the lowest in decades, and the world’s second-largest economy is facing deflationary risks as annual consumer prices fell in July for the first time since early 2021.
“Debt swap programmes won’t resolve the root problem as highly leveraged local governments may still have trouble paying off their debt going forward,” the person close to the finance ministry said. “Much slower future economic growth will undermine fiscal revenue, which is a major source of debt repayment.”
“It’s a typical chicken and egg issue,” said Ivan Chung, managing director of Moody’s Investors Services. “Without growth, how can you generate more resources to repay the debt?”
The state council, the People’s Bank of China, Ministry of Finance and China Securities Regulatory Commission did not reply to requests for comment.