China’s Local Government Financing Vehicles Face Debt Crisis

China’s Luck with Financial Crises May Be Running Out: Despite being one of the world’s most indebted countries, China has yet to undergo a full-blown financial crisis. 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 dread of such catastrophes has lessened. 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).

April 2023 Current Affairs Quiz

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. According to the IMF, LGFV debt in China would reach 57 trillion yuan ($8.3 trillion), or 48% of China’s GDP, by 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. LGFV bonds’ average return on assets in the first half of 2022 was only 0.4%, and they don’t compensate buyers for the risks they’ve taken, paying only 4.3% interest on average. This has caused concern among investors.

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 developed low-cost, high-quality services for the general public, such as high-speed trains and low-cost road trips. However, the economy is approaching a tipping point, and fiscal authorities will need to find out how to fund all of that infrastructure. China’s Minsky moment may well have come, and Beijing will have to tread very carefully this time.