In Depth: China’s Multitrillion-Dollar Salve for Local Government Hidden Debt

The November 8 announcement by China’s Ministry of Finance reveals a significant 10 trillion yuan ($1.4 trillion) package devised to aid local governments in managing their hidden debt. This financial endeavor, deemed highly substantial by Finance Minister Lan Foan, reflects Beijing's growing concerns over local governments' off-budget borrowings, a predicament that has burgeoned over the years due to accelerated state-driven infrastructure investment aligned with economic growth goals [para. 1][para. 2][para. 3].

The issue mainly arises from local governments employing local government financing vehicles (LGFVs) and other channels like public-private partnerships to secure funds for infrastructure projects, some of which struggle financially and rely on government resources for debt servicing. The practice, supposed to cease with the 2015 update to China’s Budget Law, persisted despite official prohibitions, thereby heightening the need for a rigorous resolution approach [para. 4][para. 5][para. 6].

Lan revealed the hidden debt sum to be 14.3 trillion yuan by the end of 2023, which, despite appearing below market predictions, calls for strategic measures. A prominent initiative allows local governments to capitalize on an expanded amount of special-purpose bond (SPB) proceeds. The three-year plan allots 6 trillion yuan SPB quotas and permits an additional annual 800 billion yuan SPB proceeds for five years, indicating a relaxation of prior restrictions that limited SPB usage to swap outstanding covert debt [para. 7][para. 8][para. 9].

The slump in land sales, historically lucrative for local revenues, propelled these adjustments following the downward spiral of China’s housing market in mid-2021. Notably, regions marked by high debt risk have begun implementations, reflecting gradual dissemination across the nation [para. 11][para. 12][para. 13].

Other efforts employ strategies like debt restructuring through special refinancing bonds. Approximately 1.5 trillion yuan worth of these bonds have been projected to issue during late 2023 to mid-2024. The central government is also rallying financial institutions and the People’s Bank of China to play a crucial role, orchestrating debt restructuring and ensuring liquidity via various models [para. 15][para. 16].

While conventional swap bonds have had success, experience in high-debt regions such as Beijing, Shanghai, and Guangdong suggests a partial easing in hidden debt accumulation. An analyst report from Guosheng Securities Co. Ltd. underscores a marked slowdown in debt growth, with interest-bearing LGFV debts expanding by a modest 9.5% year-over-year in 2023, which suggests potential continuity in such a trend [para. 18][para. 19].

Despite progress, some local governments reportedly bypass curbs on illegal fundraising, as indicated by a National Audit Office report highlighting 37.3 billion yuan in contentious debt, underscoring continuous challenges [para. 21][para. 22].

Addressing LGFV defaults poses challenges too, especially since non-standard debt forms have evaded clear market visibility and scrutiny. Hence, the onus falls on financial institutions and local officials to restructure such debts into transparent and manageable accounts [para. 24][para. 25].

The overarching challenge hence entails balancing debt reduction while sustaining economic growth. Local infrastructure has historically driven GDP growth, now jeopardized by funding restrictions. Some regions are experimenting with market-modified LGFVs and new industrial setups to alleviate these pressures, though often such efforts merely delay confronting the underlying debt issues [para. 27][para. 28].

Ultimately, maintaining liquidity and avoiding defaults come at the potential cost of economic stagnation, demanding strategic compromises by local authorities to effectively navigate this complex landscape [para. 29][para. 30].