GROWING RISKS FROM CHINA's LGFV DEBT

Challenges and vulnerabilities in China’s LGFVs

China’s financing vehicles (LGFVs), crucial for infrastructure funding, are facing growing vulnerabilities. These entities often struggle to generate sufficient returns and rely on municipal injections for solvency. The real estate crisis has led to cash-flow problems among local authorities, raising concerns about the $9 trillion LGFV debt market. The Chinese government is taking measures to rescue weaker issuers and prevent a credit crisis.

LGFVs’ role and importance

LGFVs were established to bypass bans on municipal borrowing, directing funds to infrastructure projects with low returns and lengthy completion periods. Despite being classified as corporate debt, LGFVs are largely seen as the responsibility of local governments.

Significance and worries

LGFVs have played a pivotal role in China’s economic growth, supporting infrastructure and public services. Their prominence surged after the 2008 financial crisis and a national stimulus plan. However, concerns have risen as LGFV debts doubled in five years, reaching about $9 trillion, over half of China’s annual economic output.

Potential risks and government response

Cash-flow issues emerged due to property slumps and pandemic-related spending, straining local governments. Though LGFV defaults have not occurred, debt-servicing risks have risen. The Chinese government is allowing provincial-level governments to issue bonds to support LGFVs. Major state banks offer longer loans, and the central bank may establish a liquidity tool. A default could spike risk perception, elevating borrowing costs and impacting China’s economic stimulus. The potential for LGFV debt to be transferred to central government balance sheets which would increase the government’s financial burden.

Impact on banking sector and investors

China’s banks feel pressure to extend maturities and reduce rates for LGFVs. Cautious lending prevails among Chinese banks and institutions. Some review portfolios to assess LGFV creditworthiness and dispose of weaker borrowers. A liquidity crunch looms for LGFVs, particularly in underdeveloped regions. The opaque nature of LGFV’s financial reporting, which makes it difficult to assess their true financial condition.

Implications for bondholders

Worsening LGFV conditions worry bondholders, especially offshore ones. Default concerns affect projects tied to LGFVs, raising worries for bondholders. Scrutiny of LGFVs’ dollar bond issuance has increased. Despite likely avoiding mass defaults, the focus remains on controlling LGFV growth and averting market panic.

What we think

China’s pursuit of economic growth amidst financial risks encounters challenges stemming from escalating local-government debt, primarily through Local Government Financing Vehicles (LGFVs). The burgeoning LGFV debt raises apprehensions regarding infrastructure financing and financial commitments, posing potential threats to China’s overall economy and financial structure.

The LGFV debt market is exhibiting vulnerabilities due to inadequate returns, dependence on municipal support, and cash-flow issues linked to the real estate crisis. The substantial debt amassed by LGFVs presents risks to China’s economic stability, prompting government interventions aimed at averting defaults and credit crises.

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