China's recent extension of measures to soften LGFV debt risk may add debt burden without improving cash flow adequacy or other key credit ratios. The intention of "Decree 134" and the earlier "Decree 35" is to help beleaguered local government financing vehicles (LGFVs) refinance maturing high-cost debt and improve their capital structures. Our analysis of some debt-laden sample cities indicates that their financing vehicles' access to bank financing and bond markets differs significantly (see chart 1).
Chart 1
What's Happening
China's recent policy extension is mainly helping some burdened LGFVs to refinance costly nonstandard debt with longer-tenor debt, including bank loans. We also believe the scope of the program is being extended beyond the 12 regions previously identified by the State Council as "highly indebted" (see chart 1). Our analysis focuses on cities where the LGFVs have missed payments or restructured nonstandard debt, or ever ran into distress. We find that some are getting more access to financial resources than others.
Why It Matters
We see Decree 134 as essentially another policy patch to buy time and buttress market sentiment. While immediate default risks are lower, this extension won't resolve the core problem that many LGFVs do not generate sufficient revenue to meet obligations.
Key credit metrics are not improving for many. One year after the policy supports were rolled out to LGFVs, cash flow adequacy is still tight for the sample cities. The entities' cash coverage for short-term maturities is very low at 0.05x-0.39x as of end June. Most of the sample cities' LGFVs also didn't manage to increase enough longer-term loans or bonds, which would have helped to significantly improve their cash adequacy.
And deleveraging seems quite remote. LGFV debt has increased for 75% of the sample cities. This is particularly so for bigger ones with much larger LGFV debt stock, probably due to a corresponding high interest burden and continuous spending needs. Debt for LGFVs from Tianjin, Chongqing and Xi'an have each increased by Chinese renminbi (RMB) 49 billion-RMB56 billion over the first half of the year.
Moreover, some of the riskiest LGFVs might not get relief. Debt refinancing or restructuring will be tough to get if operations lack financial sustainability or don't have a clear and concrete debt resolution plan, constraining the feasibility of deals. Under this situation, entities may have to seek channels that are more expensive, such as offshore bond issuance or nonstandard debt.
What Comes Next
Reforms may get pushed further out. While deleveraging LGFVs remains the ultimate policy goal, debt may continue to rise for entities in many cities. Long-term bank loans or bonds can help refinance part of their short-term maturities, but the debt remains to be repaid. Revenues are unlikely to improve without a rebound in the property market or stronger economic momentum. Many past LGFV investments are not made into profitable or self-sufficient assets.
Moreover, LGFVs may find it hard to cut spending significantly, due to other directives from their respective governments—such as buying property from local hard-hit developers and participating in land auctions, social housing or continuing infrastructure buildouts.
If funding from local governments, which also have fiscal constraints of their own, diminishes more rapidly, it could also counteract these measures. This year, we expect Special Refinancing Bond issuance to be lower than last year (2023: RMB1.4 trillion). This issuance is a more direct and transparent form of local-government borrowing to settle its off-budget debt.
Related Research
- Is It Working? China's LGFV Debt De-Risk Program One Year On, July 25, 2024
- Your Three Minutes In China LGFV Bonds: Weaker Entities Go Long, June 27, 2024
- Record Bond Rejections To Squeeze China's Lower-Tier LGFVs, April 11, 2024
- China LGFVs' Bigger Housing Role: Risk Control Matters, March 27, 2024
This report does not constitute a rating action.
| Primary Credit Analyst: | Laura C Li, CFA, Hong Kong + 852 2533 3583; laura.li@spglobal.com |
| Secondary Contact: | Christopher Yip, Hong Kong + 852 2533 3593; christopher.yip@spglobal.com |
| Research Assistant: | Chen Guo, Hong Kong |
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