China's local governments are finding it difficult to service debt raised via municipal and Local Government Financing Vehicles (LGFVs) bonds, as their fiscal position has become tight due to the slowing economic growth and fall in revenue receipts amid a downturn in the property market.
According to S&P Global Ratings analysts, local government direct debt exceeded 120 per cent of revenue in 2022.
As per the IMF, the explicit on-the-books debt of local governments, including bonds, was USD 5.3 trillion. However, implicit debt, including LGFV debt, amounted to USD about 15.3 trillion.
In the next five years, municipal bonds worth almost USD 2.1 trillion (40 per cent of their outstanding debt) are to mature. Along with the maturing municipal bonds, there is an increasing debt burden of bonds sold by LGFVs, which are off-balance platforms. About USD 790 billion worth of onshore bonds of LGFVs are coming due this year, the highest since 2021.
A potential bond repayment default could undermine the country's economic recovery and threaten its financial stability. As per economists, China's high level of municipal borrowing would be the largest financial risk this year. A recent last-minute bond payment in Kunming, the capital of Yunnan, by a local government-owned firm points towards weakening the debt serviceability of local governments.
So far, there have been no reports of an LGFV default, but some have had the period of their loans extended. However, any delayed payments by the LGFVs would raise the risks of a possible bond default in the listed market.
China's local governments are facing a vicious circle of issuing more bonds to roll over maturing ones as they face financial squeeze due to falling revenue from land sales and stimulus measures to revive businesses. This is likely to affect future investment in crucial sectors of the economy, which ultimately would put pressure on economic growth.
There is growing concern that due to the increasing debt burden and falling revenue, local governments would cut back on spending on public services. There are reports that many local governments, like in Hegang, Shangqiu, Wuhan, Guangzhou and Shanghai, have failed to pay the salaries of teachers and government employees, have rationed natural gas, restricted public bus services, auctioned off public schools and slashed pensions and health benefits.
The population in the northern province of Hebei was without heating in November and December last year because of a shortage of natural gas and was further affected by the cuts in government subsidies. In January, households in the city of Hegang in Heilongjiang province were also left without heat after local companies restricted supply.
In case the debt problem of the local governments becomes acute, it would affect banks and interest rates. According to the Centre for Strategic and International Studies (CSIS), Chinese banks, the largest creditors to LGFVs, would see a large increase in non-performing assets from even small defaults by LGFVs. Some local governments are already pushing banks to extend maturities and cut interest rates
The debt raised by the local governments to push infrastructure projects to meet central government targets, especially through LGFVs, is now proving to be unsustainable. For example, Guiyang was seeking help from the central government as it does not have the ability to repay its debts. This indicates an emerging crisis in local government debt in the coming months.
The situation is becoming increasingly difficult at a time local-government finances have been strained due to strict Covid-19 controls and a property sector slump that cut into land sales. Local governments will have to go in for spending cuts or divert money away from infrastructure projects to continue repaying their debt.
The country's efforts to revive the economy by increasing infrastructure investment would face headwinds due to financial risks from massive local government debt. China's slower growth would also make it difficult for revenue receipts to keep pace with the growing total Chinese debt. Already total Chinese debt is about USD 52 trillion, almost three times its GDP. Matters are likely to get worse, which will slow China's pace of economic growth. (ANI)