FEARS OF DEFAULT RISE AS PROVINCES’ DEBT WOES MOUNT

Ability of local governments to repay borrowings is under question, as is Beijing’s willingness to offer support and shoulder some of the burden

The local government debt crisis is approaching a tipping point as concerns over default risks by city and county authorities mount and Beijing’s willingness to offer enough support to avert a meltdown is questioned.

Last month, Kunming, capital of the southwestern province of Yunnan, denied online reports that its local government financing vehicles (LGFVs) were having difficulty repaying debt after one of them was involved in a last-minute scramble to repay 2 billion yuan (HK$2.2 billion) on May 21.

LGFVs were created to aid offbudget financing, especially for infrastructure spending, but weak disclosure requirements have led to concerns about hidden debt risks.

In April, a government think tank in Guizhou warned that the province, which neighbours Yunnan, could not manage its debt on its own and needed help from the central government. The report was subsequently removed by censors.

Over the past few years, Beijing has stepped up its supervision of local government debt in a bid to curb risks and has said that local governments should not count on a state bailout.

But Yu Yongding, a prominent economist and former central bank adviser, said the central government’s approach of relying on local authorities to sort out their debt problems was wrong.

“Local governments are the offspring of the central government, and the central government must also assume certain responsibilities,” Yu wrote in a blog post published by the Economists 50 Forum, a Chinese think tank.

“Importantly, resolving local government debt should not lead to a further decline in economic growth. Of course, moral hazard cannot be encouraged. Those who are directly responsible for causing the deterioration of local debts should also bear corresponding responsibilities.”

Yu estimated that the central government only contributed around 0.1 per cent of infrastructure spending, compared to nearly 60 per cent by LGFVs, which incurred higher borrowing costs.

Hu Jie, a former senior economist at the US Federal Reserve Bank of Atlanta and now a professor at Shanghai Jiao Tong University, said the ratio of local debt to gross domestic product (GDP) in many provinces was already “too high”.

Deleveraging “too quickly” might trigger a series of defaults, Hu told the Shanghai-based news website guancha.cn in an interview last month.

“But when a local government has problems and cannot clean up the mess, the central government cannot stay out of it,” Hu said.

There are no official figures for local governments’ off-balance sheet borrowing but most estimates indicate it has been growing.

In a report published in February, the International Monetary Fund estimated that the total debt of China’s LGFVs had swollen to a record 66 trillion yuan this year, more than double the 30.7 trillion yuan in 2017.

Another estimate, by French investment bank Natixis, put China’s public debt in the last quarter of 2022 at 95 per cent of GDP. The US’ is 120 per cent and the euro zone’s is 92 per cent. But Natixis acknowledged there were limitations to its estimates as they relied on public disclosure and some data was not readily accessible.

China’s renewed infrastructure spending push to support the economy has raised questions about the sustainability of local government debt.

Many local governments have seen their fiscal revenue tumble, property markets stumble and refinancing costs rise.

Last month, the finance bureau in Wuhan, capital of central Hubei province, publicly named hundreds of debtors in a local newspaper article demanding payments dating back to December 2018, a rare move underscoring the fiscal problems facing local governments.

Li Daokui, director of the Academic Centre for Chinese Economic Practice and Thinking at Tsinghua University and a former adviser to the People’s Bank of China, said the central government should take over some of the local government debt burden.

“Relying entirely on local finance and the profits of local state-owned enterprises are not enough to cover the cost of interest repayment, not to mention repayment of principal. This is unsustainable,” Li said at a forum arranged by the university last month.

“Our institute has suggested that, in the future, debt issuance must go through certain procedures. At the same time, a considerable part of local debts should be transferred to the central government.”

Analysts said investor confidence would suffer if there was no long-term solution to China’s debt crisis. Since the start of the year, most LGFVs in Kunming had lost access to the capital market and were mainly relying on funds from the local government, Minsheng Securities said last month.

“Perhaps markets believe the probability of final repayment is still high, but these small hiccups in the process will further increase the regional pressure that can turn into a negative cycle,” it said.

“In the future, if you want to restore the recognition of the capital market and to sell bonds in the market again, one can imagine the difficulty.”