Risks for China's local government financing vehicles, or LGFVs, have been amplified after they issued a record US$39.5 billion in cross-border debt in 2022 amid higher global interest rates, according to S&P Global Ratings.
As the LGFVs have been struggling to replenish liquidity amid tough macro conditions and a lack of better funding alternatives onshore, many of them are heading offshore for fresh financing despite unfavorable rates, Ratings said in a Jan. 9 report.
"The weaker LGFVs are forced to pay the highest prices, driving a further wedge in the sector's credit quality," said Yuehao Wu, credit analyst at S&P Global Ratings. "Should regulators crack down on cross-border borrowings, weaker players could face increased default risk."
China has reversed most of its strict COVID-19 policies in recent weeks as it seeks to reopen its economy and bolster growth. Still, the world's second-largest economy will most likely miss its 2022 GDP growth target of 5.5%, set during the March 2022 political meeting, after recording 4.8%, 0.4% and 3.9% year-over-year growth in the first three quarters of 2022, respectively. While COVID-19 infections have increased, according to local media reports, economic and social conditions are likely to return to normal within several months, CICC said in a Jan. 9 note, adding that it believes uncertainty for the private sector is easing.
Zero-COVID pivot
"The earlier-than-expected pivot away from the zero-COVID policy indicates that the local governments are very stressed and there's a need to release the pressure," Nicholas Yao, Hong Kong-based head of China equities at asset manager abrdn, told S&P Global Market Intelligence on the sidelines of a Jan. 10 seminar.
"Total credit in the Chinese economy keeps rising and leverage isn’t declining ... so the local governments have to find the way to generate enough revenue growth," added Jeremy Lawson, chief economist and head of abrdn Research Institute.
Access to new funding is key for the financial sustainability of LGFVs as many of them "have weak ability to generate cash flow," given their legacy of financing social or welfare projects and services with little profitability, Ratings said in its report. Governments, squeezed by COVID-19 costs and the property downturn, have less capability to clear receivables owed to their financing vehicles, the report added.
Record issuance
The record issuance in 2022 was fueled by the refinancing need for the last issuance peak in 2019, and the net issuance after repayment was still US$6.5 million, the rating agency said.
Ratings believes most of the fresh cross-border issuance is being driven by the latest round of regulatory restrictions on LGFV financing to contain the "hidden debt" at the vehicles, or off-budget borrowings of the local government owners.
S&P Global Ratings' Wu noted, however, that so far, no LGFV has officially defaulted on a bond, despite a number of close calls and quickly rectified late payments.