Larger local govt debt may add to China's credit risk

The Chinese government’s intention to sell $203 billion of local government debt marks a departure from deleveraging to stimulus. But it is likely to increase China's debt problems.
Local governments in China plan bond sales to stimulate infrastructure spending
Local governments in China plan bond sales to stimulate infrastructure spending

The Chinese government’s intended sale of Rmb1.39 trillion ($203 billion) of local government debt is a sign that it has moved away from deleveraging to stimulating the country's flagging economy. But the bond sale also risks exacerbating the country’s severe debt problem.  

“It’s not going to stimulate growth and it’ll worsen the debt problem,” said Cliff Tan, East Asian head of global markets research at MUFG, at a recent press conference. “China is going back to the old playbook. The old playbook is to stimulate, backed by financing. That is going to increase credit risks.”

On January 2, China’s Ministry of Finance announced the early sale of Rmb1.39 trillion of local government bonds. This is to be made up of Rmb580 billion of general bonds and Rmb810 billion of special bonds. The former are used for general budget expenditure, while the latter are dedicated to a specific project, usually infrastructure.  

In early January, state news agency Xinhua reported that local governments expect to issue Rmb2.2 trillion of special bonds this year. This is a big increase on previous years. Local governments raised Rmb800 billion from special bonds in 2017 and Rmb1.35 trillion last year, according to the Finance Ministry.

Local government debt would normally be announced after the National People's Congress in March or April with special purpose bonds issued in around May or June. But In January alone, more than Rmb240 billion of local government bonds could be issued.

“We believe there is a strong interest in these bonds,” said Angus To, deputy head of research at ICBC International Research.

“Currently, the liquidity of the banking system is relatively abundant. The yield of local government bonds is more attractive than treasury bonds. Local government bonds are less risky when compared with corporate bonds,” he added.

Jianwei Xu, Greater China senior economist of Natixis, believes that early bond issuance will both increase market liquidity, and interest in China's bond market. 

Although local investors account for most of the purchases of local government bonds, interest has gained steadily among global investors. Bond Connect, the platform that allows Hong Kong investors to trade Chinese bonds, reported a foreign investor volume of Rmb3.4 billion in December.  


One reason for the early announcement of local government bond issuance is to boost infrastructure investment. It is a counter the US-Sino trade tensions and the flagging Chinese economy, explained Terry Gao, senior director of international public finance at Fitch Ratings.

Infrastructure spending is definitely on the up. At the start of the year, China’s National Development and Reform Commission (NDRC) announced plans for an Rmb146.9 billion urban railway system in the Chinese city of Wuhan by 2024. Since December, the NDRC has approved infrastructure projects worth at least Rmb930.2 billion in at least five cities including Shanghai, Hangzhou and Chongqing, and several regions in the nation.

“Fixed asset investment data shows that infrastructure investment has picked up but only slowly. This needs to speed up to support the economy,” said Iris Pang, Greater China economist at ING Bank.

Infrastructure spending in the country dropped from 19% in 2017 to 3.7% during the first 11 months of 2018, according to official Chinese data. The World Bank also projects that China’s GDP growth will slow to 6.2% in 2019 from an expected 6.5% in 2018.

To prevent the Chinese economy from worsening, Beijing needs to enhance monetary stimulus, said Xu"Against this backdrop, the aim to deleverage is no longer a priority for the Chinese government."

China’s debt is likely to continue to grow this year, given the expansionary policy stance of the Chinese government, Xu added.

MUFG's Tan points out that if hidden debt estimates are included, China’s debt may now be nearly 300% of GDP. This is higher than US debt during the global financial crisis in 2008.

Although China’s official public debt-to-GDP ratio is below 60%, Beijing camouflages public obligations. It does not include the debt of state-owned enterprises and it disguises some local government debt. “I’m not predicting a crash this year. But I shouldn’t be surprising if China experiences a rocky landing several years down the road,” Tan said.

Using the analogy of a car crash, Tan explains that while a crash destroys a car, a rocky landing inflicts severe damage but the car is salvageable.

Based on official audits and statements by Chinese officials, Tan has seen estimates of total local government debt soar from Rmb18 trillion in 2013 to Rmb24 trillion in 2015.

According to the Finance Ministry, local governments had total outstanding debts of Rmb17.7 trillion at the end of August last year. But S&P Global Ratings believes that this does not tell the full story.

In an October report, the ratings agency estimates that local governments may have accumulated as much as Rmb40 trillion of hidden debt which is not reflected in the official figures. This is “a debt iceberg with titanic credit risks,” it warned.

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