Unreported Chinese local governments debt may have accumulated over 40 trillion yuan ($5.8 trillion) from off-balance sheet records. This could mean that the country’s debt-to GDP ratio has hit alarming levels, S&P Global Ratings said in a report released Tuesday…
Unreported Chinese local governments debt may have accumulated over 40 trillion yuan ($5.8 trillion) from off-balance sheet records. This could mean that the country’s debt to GDP ratio has hit alarming levels, S&P Global Ratings said in a report released Tuesday.
Background
China is the second largest economy in the world after the USA. According to certain forecasts, its GDP growth is slated to overtake America’s GDP in another 10 years. A hub for the manufacturing industry, China is the fastest growing economy. Its economic growth has been over 10% for over 30 years.
However, in recent years, China’s exponential growth has come at the cost of increased debt. According to statistics, its debt is more than 250% of the GDP and is much higher than the US. It is, however, lower than Japan, which remains the world’s most indebted leading economy. Experts have said that if China’s trajectory continues, then it will be looking at an economic slump sooner than later.
Due to China’s increasing build-up of credit, Standard & Poor Ratings has downgraded China’s long-term sovereign credit by one step. The nation’s credit has gone from AA- to A+.
Analysis
China’s local governments may have accumulated 40 trillion yuan ($5.8 trillion) of off-balance sheet debt, or even more, suggesting further defaults are in store.
“The potential amount of debt is an iceberg with titanic credit risks,” S&P credit analysts led by Gloria Lu wrote in a report Tuesday. Much of the build-up relates to local government financing vehicles, which don’t necessarily have the full financial backing of local governments themselves.
With the national economy slowing, and a Beijing-set quota for the issuance of local-government bonds not being enough to fund infrastructure projects to support regional growth, authorities across the country have resorted to Local Government Financing Vehicles (LGFVs) to raise financing, according to S&P. That’s left LGFVs “walking a tightrope” between deleveraging and transforming their businesses into more typical state-owned enterprises
Rising vulnerabilities among LGFVs occur against a backdrop of a record pace of defaults this year in China, which has sought to roll back a decades-old practice of implicit guarantees for debt. The focus on funding to sustain growth at the local level echoes a broader shift in the central government, which last year was focused on reducing leverage in the financial system. That phase is essentially over, thanks in part to an escalating trade war with the U.S., according to Citigroup Inc. analysts.
Even with the central government’s shift toward the stimulus, however, S&P sees Beijing determined to “bring discipline to the financing practices of local governments and their LGFVs.” That ultimately may mean local authorities aren’t fully able to keep LGFVs afloat, however, and the bottom line is “the default risk of LGFVs is increasing.”
Moody’s Investors Service last month downgraded five Chinese non-financial corporate and infrastructure issuers owned by regional and local governments in Tianjin, Jiangsu, Hunan and Hubei, while Fitch Ratings said in July that authorities’ efforts to reduce implicit and explicit credit guarantees offered by local governments had increase default risks of “non-core” issuers.
Jiang Chao, the chief economist at Haitong Securities in Shanghai, wrote in a research note in July that hidden debts by local governments could be as much as 30.6 trillion yuan (US$4.4 trillion) in 2017. He wrote that the annual growth rate of outstanding hidden debts over the past three years was more than 77%, much higher than the 2.4% of disclosed debts.
Assessment
Our assessment is that the actual level of off-balance sheet Chinese local government debt could be several times more than what is publicly disclosed and the range could be between $4.34 trillion to $5.78 trillion. We believe Chinese economic growth is losing steam amid the trade war with the US and Beijing is changing track to aid growth by accelerating infrastructure funding and moderately easing monetary policy. We feel that the default risk of LGFVs is higher than before, though it is difficult to predict when this would happen.
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