China Clamps Down on Local Officials in Bid to Tackle Troubled Debt
(Beijing) — China is putting more teeth into efforts to constrain mounting government debt, vowing both to hold officials accountable for bad loans and to wean lenders from their addiction to government bailouts, analysts said.
China has relied heavily on government-backed infrastructure projects and an overheated property market to fuel growth in recent years. As a result, local authorities embarked on a borrowing binge that is turning increasingly risky as debts pile up and economic expansion loses momentum.
Beijing has issued a series of policies to rein in reckless borrowing, such as off-balance-sheet borrowing and other shadow-banking activity. It’s restricted local governments to issuing bonds and has announced the central government will no longer provide bailouts when defaults occur.
And, for the first time, Beijing has clarified what consequences reckless officials may face.
The Local Government Debt Risks Contingency Plan specifies that local governments will take only limited or even no financial responsibility for state-owned company liabilities they have previously endorsed. This is likely to force lenders to exercise more caution when it comes to giving out cash.
“The plan, by bringing both creditors and debtors under pressure, will help make local government debt be managed in a more regulated and orderly manner,” Zhao Quanhou, a researcher with the Chinese Academy of Fiscal Sciences, which is affiliated with the Ministry of Finance, told Caixin.
The plan says regulators will carry out investigations if risks such as payment defaults on local government bonds occur, and that responsible officials will be punished according to the law, even if they have left their posts.
“That will serve as a warning to some local officials who tend to rely on debt to fund construction projects and will curb the growth of local government debt,” said an analyst with a ratings company who asked not to be named.
However, she cautioned that the extent that the new rule can restrict the growth of debt remains uncertain because the government needs to stabilize the economy. Gross domestic product slowed to 6.7% in the first nine months of this year, after dipping to 6.9% in 2015 — its weakest pace in a quarter-century.
Under the plan, creditors who hold certain types of debt, such as some urban construction investment bonds issued by local government financing vehicles (LGFVs) before the end of 2014, must swap them for local government bonds, which analysts say are safer but offers lower returns.
Otherwise, the government will back away from any promise to guarantee repayment, and creditors will have to seek funds directly from the borrowers, risking higher rates of default.
“The bargaining power of those holding construction investment bonds will likely be undermined after the plan comes into force,” said Ji Jiangfan, an analyst with China International Capital Corp.
The Ministry of Finance’s goal is to swap 14.34 trillion yuan ($2.1 trillion) in non-bond debt into local government bonds within a three-year period that began in 2015, mainly to reduce interest costs and increase transparency about local fiscal borrowing. The total amount of local government debt by the end of 2014 acknowledged by authorities was 15.4 trillion yuan.
By the end of September, 7.2 trillion yuan in the debt had been converted.
In practice, local governments often issued bonds to new investors and used the proceeds to redeem old debt before it was due. They did this instead of swapping the new bonds directly with existing creditors who were often reluctant to make the exchange because of portfolio maturity mismatches and other concerns.
In the past, creditors could reject the early redemption, which generally meant they were not fully repaid, in hopes that local governments, which were under pressure to clear up shadowy forms of debt, would raise the offer.
Now creditors cannot afford further delays because the plan stipulates that the assets will be disqualified as a government obligation if they don’t take the deal, putting the original debt at a higher stake of default, Ji said.
Separately, the plan made it clear that previous government-guaranteed credit to companies won’t be considered a government obligation, and it capped official reimbursement of such liabilities at 50% of the amount the firms fail to pay.
Huang Weiping, an analyst with Industrial Securities, believes the regulation will lower the market valuation of urban construction bonds.
“With the separation of local government credibility from central government credibility — and urban construction investment turning to be more of a corporate business — the fundamentals of low-quality urban construction investment bonds are weakening, and it is possible that LGFVs may default on such bonds,” Huang said.
And the impact of the plan may go beyond that, Ji said.
It raised questions and sparked concerns among investors about how the government will deal with projects such as low-income housing that needs long-term fiscal commitment of support and even procurement and reimbursement.
Contact reporter Fran Wang (firstname.lastname@example.org)
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