China’s rescue plan to resolve its local government debt crisis has thus far provided only temporary fixes, with default risks remaining significant and the debt pile set to grow in the coming two years, according to a new S&P Global Ratings report.
A series of measures implemented a year ago after a meeting of the Politburo – the centre of power within the Communist Party – included a debt-swap programme and loan restructuring aimed at defusing what threatens to be a financial time bomb that could damage China’s banking system.
“So far, we see temporary fixes for China’s heavily indebted local government financing vehicles (LGFVs),” S&P Global Ratings credit analyst Laura Li said in the report, released on Thursday.
“The measures are more focused on ‘buying time’ than addressing the weak fundamentals of local government corporate arms.”
It is difficult to reverse course after years of rapid debt growth from LGFVs, the US rating agency said.
LGFVs, which have proliferated since the global financial crisis in 2008, are hybrid entities that are both public and corporate and were created to skirt restrictions on local government borrowing.
Wenyin Huang, S&P Global Ratings
“Last year, LGFV-debt growth dropped moderately – but was still single-digit growth. We think borrowings will likely grow at a mid-to-high single-digit level over the next couple of years,” the report said.
Under the package of measures announced last year, local governments, financial institutions and investors are all required to shoulder some of the cost of resolving this sector’s outsized debt burdens, the report added.
“In our view, local and regional governments will try to avoid any type of default that would cause systemic risk,” said S&P Global Ratings credit analyst Wenyin Huang. “However, they are likely to allow low-impact credit events to happen, such as defaults on selected non-standard debt and commercial paper.”
The S&P report suggested that smaller regional banks, especially those in northeastern and southwestern China, will suffer the most relative to their asset size, since they have the highest exposure to weaker LGFVs.
The International Monetary Fund estimated that China’s total LGFV debt hit 66 trillion yuan (US$9.1 trillion) in 2023, or more than half of the nation’s gross domestic product.
Finance minister Lan Foan has said coordinated efforts have led to an overall alleviation of local debt risks, that debt problems remained under control, and that associated risks were being addressed through “high-quality development”.
However, while there has not been a default in the listed market, LGFVs have missed interest payments and defaulted on their borrowings in private transactions, according to estimates from Shenwan Hongyuan Securities.
The Chinese broker estimated that there were at least 49 credit-risk events in the first half of 2024 for LGFVs, up from 41 over the same period in 2023, and that two-thirds of the risk events were actual defaults.
Financing vehicles from Shandong and Guizhou provinces accounted for 74 per cent of all credit-risk events, according to a note by the broker last week.
Government finances also have not improved. In June, national fiscal revenue posted a 2.6 per cent year-on-year contraction, following a 3.2 per cent drop in May, data from the Ministry of Finance showed on Monday.
Bank of America estimated that revenue growth contracted by 1.1 per cent in June, compared with a rise of 2.1 per cent in May.
The US bank also estimated that, for the first half of this year, actual fiscal revenue was only at 51.8 per cent of the annual budget, below the rate seen most years, except for 2022.
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