China’s Economy faces new challenges
2023.03.10 01:34
China’s Economy faces new challenges
By Ray Johnson
Budrigannews.com – China’s efforts to boost the economy this year by spending more on infrastructure and avoiding financial risks are hindered by the massive debt held by local governments, which is now over $9 trillion and growing.
According to sources, as debt obligations rise, some local governments are urging banks to extend maturities and reduce interest rates. According to Fitch, the amount of onshore bonds due from Local Government Financing Vehicles (LGFVs) this year is the highest since 2021—5.5 trillion yuan, or $790 billion.
Concerns about LGFVs’ ability to meet debt obligations and its impact on the broader banking sector and markets have been fueled by a sharp drop in income from main land sales and a lack of options for raising additional funds.
Because LGFVs play a crucial role in funding infrastructure projects, which are one of the biggest growth drivers for the world’s second-largest economy, it will also be a key test for China’s modest economic growth target of around 5% this year. This will be a key test for the ability of fiscally stretched local governments to follow through on spending.
There have been no public reports of LGFV defaults thus far, though some have had their loans extended.
“The LGFVs are now the financial system’s black hole in China. According to Andrew Collier, managing director of Orient Capital Research, “they have been used to fill the gap between the revenue and expenditure of local governments.”
He stated, “They cannot pay back their debt owed, and they have little or no profit.” I anticipate that many LGFVs will fail or be quietly recapitalized by banks, putting some rural banks and bondholders in danger of default.”
According to a report released last month by the International Monetary Fund (IMF), the total debt of China’s LGFVs has increased from 57 trillion yuan last year to a record 66 trillion yuan ($9.5 trillion), or half of the country’s economy.
The government is attempting to free the economy from the grip of a property debt crisis that has gripped the economy for the past few years. In that crisis, a number of developers defaulted on their debt, and land sale revenues plummeted, forcing Beijing to implement a slew of supportive measures. This has led to concerns about the deteriorating credit profile of the company.
According to Wang Tao, chief China economist at UBS, “LGFVs are under considerable pressure on debt repayment this year, because their income is frequently associated with real estate and land sales.”
When he delivered the government report on Sunday, as China’s two sessions began, Chinese Premier Li Keqiang listed “preventing and defusing local government debt risks” as one of the major tasks for the government in the coming year.
According to three sources with knowledge of the situation, this priority comes at a time when some Chinese banks with exposure to LGFVs are increasingly receiving requests to reduce interest rates and extend their near-term maturities by as much as six months.
Due to the sensitive nature of the situation, the sources, who refused to provide further information, could not be identified.
Over the past few years, Chinese banks and other financial institutions have been wary about making new loans to LGFVs.
According to separate sources in the financial sector, some state-owned banks, asset managers, and insurers have been looking into their portfolios in recent months to screen LGFV borrowers with lower creditworthiness and dispose of them.
According to ratings agency S&P, LGFVs used dollar bonds to raise a record $39.5 billion last year, and industry sources claim that offshore branches of Chinese financial institutions have been the primary buyers of the bonds.
However, authorities have increased their scrutiny of LGFV dollar bond issuance since late 2022. According to two distinct sources with knowledge of the situation, the National Development and Reform Commission (NDRC) rejected requests from units with lower credit ratings as part of its efforts to reduce risks in the financial sector.
Both the China Banking and Insurance Regulatory Commission (CBIRC) and the NDRC did not immediately respond to inquiries for comment.
According to a report released last month by Fitch Ratings, a deterioration in access to capital markets can increase refinancing risk and exacerbate the LGFV sector’s liquidity crunch. Additionally, units located in less economically developed regions are more susceptible to this risk.
Some shadow banks, which are lenders to industries that are unable to directly access bank funding, are also concerned about their exposure to LGFVs as a result of the deteriorating outlook for these entities and are reluctant to make new loans.
According to Alicia Garca Herrero, chief economist for Asia Pacific at Natixis, “LGFVs used to be financed in the shadow banking (sector), but increasingly it has moved to the onshore bond market and, in some cases, offshore.”
“It seems obvious to me that a number of projects may default, which would have consequences for bondholders, particularly those in offshore jurisdictions,”
Since this would make debt market access more difficult for both public and private issuers at a time when efforts are being made to revive the economy following the dismantling of three years of stringent COVID-19 measures, some analysts believe that the Chinese authorities would avoid large-scale defaults by LGFVs.
“LGFV obligation itself as a portion of Gross domestic product is as yet sensible at this stage. According to Zhiwei Zhang, chief economist at Pinpoint Asset Management, “The key issue is to stop the rapid growth and avoid defaulting to cause panic in the market.”
