Property crisis affects state debt

Authorities emerge as white knights to aid ailing firms

“Once the policy wind turns, we don’t rule out the possibility of LGFV public bond defaults.” Zerlina Zeng

BEIJING: China’s deepening property crisis is piling pressure on a US$1.6 trillion (RM7.5 trillion) corner of the country’s onshore bond market, as cities and local administrations step in as white knights to bail out troubled developers in a state-backed bid to aid the sector.

After replacing builders as the biggest buyers of land earlier this year, the nation’s so-called local government financing vehicles, or LGFVS, have now become the main purchasers of half-finished projects of defaulters including China Evergrande Group.

Their increasing involvement in real estate has analysts raising red flags.

Moody’s Investors Service said that could weigh on the credit profile of these state funding agencies. While no LGFV has defaulted in the current cycle, Bloomberg Economics isn’t ruling out one ahead.

Though China’s loosened monetary policy has largely pushed onshore borrowing costs to the lowest in years including for most LGFVS, average credit spreads on some of the worst-performing LGFV local bonds have almost doubled since mid-january to nearly 10 percentage points.

Such direct rescue efforts and tighter ties to property are raising new concerns over the health of the weakest links in China’s state sector, as a record housing slump and surging Covid-induced expenditures squeeze the already strained finances of companies reliant on government funding.

A potential default could cause another convulsion in a market, where LGFVS’ 11.6 trillion yuan (US$1.6 trillion or RM7.52 trillion) of notes account for about a third of China’s local corporate bonds.

The government needs to rely on LGFVS during an economic downturn, but “once the policy wind turns, we don’t rule out the possibility of LGFV public bond defaults,” said Zerlina Zeng, senior credit analyst at Creditsights in Singapore.

“China will likely refocus on cleaning up local government debt” when growth picks up, she said, adding default risks aren’t elevated over the next six months.

David Qu and Chang Shu at Bloomberg Economics estimate total LGFV debt, including bank borrowings, to be as much as 60 trillion yuan (RM39 trillion), or about half of China’s gross domestic product. Defaults would have major consequences, they said.

LGFVS rose to prominence in the wake of the global financial crisis, when they played a crucial role in funding roads, bridges and subways as the central government stepped up stimulus to keep the world’s No. 2 economy humming. The phenomenon of LGFVS buying pending projects is especially acute in the southern Guangdong province, a trading hub with relatively stronger fiscal health.

Guangzhou City Construction Investment Group, backed by the city of Guangzhou, in October purchased the plot meant for a 80,000-seat football stadium after Evergrande returned it. The property giant, which is at

the centre of the credit crunch that’s rippled through the sector, has a significant number of projects in the city.

With the deal, the LGFV is now responsible for finishing the sports complex, one Evergrande estimated to cost 12 billion yuan (Rm7.78bil) but in which it had only invested two billion yuan (Rm1.3bil).

That means extra spending on top of the 57 billion yuan (Rm37bil) of real estate projects as of March. China Lianhe Credit Rating Co warned that the expenditure needs to be borne by the LGFV.

The types of LGFVS helping out are expanding to entities affiliated to lower levels of governments as well. In adjacent Shenzhen city, a district LGFV extended help to four key projects Evergrande owns in the jurisdiction, according to the developer.