China Clarifies Rules on Addressing Local Governments’ Hidden Debt

China’s multiple regulators jointly issued rules on how to deal with matured hidden debt accumulated by local government financing vehicles (LGFVs), the trickiest part in defusing the hidden debts of local governments.

The Ministry of Finance, the central bank, the National Development and Reform Commission, the top banking and securities regulators and other ministries jointly issued a document providing clear guidelines on how the LGFVs can take out new borrowings to repay their old debts or roll over their debts, Caixin learned. Related training will be conducted in late July.

The overall principle of the new document is to ensure the capital chain won’t be disrupted and to resolve the hidden debts gradually over several years, a provincial finance official told Caixin. The provincial governments will soon release their own implementation documents, the official disclosed.

There have been no official data on local governments’ hidden debt, but some research institutes have estimated that such unofficial liabilities of most provinces could be more than two times their on-the-books borrowing, which stood at nearly 18.4 trillion yuan ($2.68 trillion) at the end of last year.

Economists from investment bank Nomura International (Hong Kong) Ltd. estimate that the off-balance sheet local government debt amounted to around 40 trillion yuan as of the end of last year, and the interest payments alone could reach 600 billion yuan in 2019.

Such hidden debts are mostly short-term borrowings. Several people from local governments told Caixin that a large amount of local hidden debt will mature in three years. For example, one province in central China has nearly half of its hidden debts maturing between 2019 and 2021, an official told Caixin.

Beijing has clearly recognized that implicit local government debt at current levels is unsustainable, and measures must be taken to prevent defaults and resulting financial instability.

It’s not plausible for local governments to raise funds through various channels to repay all the principal and interest. The ultimate solution to solve the debt risk is through bankruptcy restructuring or liquidation, but such market-based mechanisms are difficult to achieve under current conditions.

Market institutions widely believe that rolling over and borrowing new debts to repay old debts are currently the plausible ways to deal with the implicit debt risk.

Zhenjiang, an eastern city of Jiangsu province famed for producing fragrant black vinegar, is at the center of a debate about how to clean up its trillions of yuan of hidden local government debts. A bailout plan involving policy bank China Development Bank, which reportedly agreed to provide special long-term loans of as much as 20 billion yuan ($2.9 billion) at low interest rates to a Zhenjiang LGFV, has raised concerns and failed to get approval from the Ministry of Finance and other regulators.