China’s Luck with Financial Crises May Be Running Out
China has yet to experience a full-blown financial crisis despite being one of the most indebted countries in the world. While there have been close calls, such as the government seizing a regional bank in 2019 to prevent a run on deposits and a wave of real estate developer defaults last year, the fear of these events has diminished. Beijing’s tightening of regulations on unregulated local banks and aggressive home builders has contributed to making China a safer place for investors. However, there is still a looming issue with borrowing from local government financing vehicles (LGFVs).
Fiscal Maneuvering on an Epic Scale: Local Government Financing Vehicles in China
For years, municipalities in China have relied on LGFVs to finance infrastructure and support the local economy. The IMF estimates that LGFV debt in China will rise to 57 trillion yuan ($8.3 trillion) or 48% of China’s GDP in 2022. This is massive fiscal maneuvering that is roughly the same size as official central and local government borrowing combined.
Investors Nervous as LGFVs Struggle to Service Debt
While these vehicles regularly raise funds through corporate bond issues, accounting for over 40% of the total market, their ability to service their debt is poorer than that of developers. Their mandate is non-profit and to provide public services. In the first half of 2022, the average return on assets among LGFV bonds was only 0.4%, and they aren’t compensating buyers for the risks they’ve taken, paying only 4.3% interest on average. This has made investors nervous.
LGFVs’ Debt Crisis Worsened by Land Sales Decline
Furthermore, if assets decline, municipalities may not be able to help their LGFVs even if they wanted to. Before COVID, regional officials received around 20% of their income from land sales, which declined by 23% last year. This has led to local authorities turning to LGFVs to fix their financial problems, making matters worse.
Poor Provinces Lobby for Central Government Bailout
The poorer provinces are lobbying for a central government bailout, and some have struggled to solve their debt problems. LGFVs have created affordable, quality services for the masses, such as high-speed trains and low-cost road trips. However, the economy is in a ripe stage now, and fiscal authorities will have to figure out how to pay for all that infrastructure. China’s Minsky moment may well have come, and Beijing will have to tread very carefully this time.
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