China's recently announced US$1.4 trillion-equivalent debt resolution plan aimed at local government financing vehicles (LGFVs) will likely fall short of actual deleveraging. S&P Global Ratings believes the plan will dramatically reduce hidden debt held by the vehicles. However, their total debt continues to rise fast, and LGFVs will have the responsibility to manage and repay their own corporate debt, which is much larger.
What's Happening
China has approved issuance of another Chinese renminbi (RMB) 10 trillion in special-purpose bonds by 2028. The program will let local governments swap out bond proceeds for "hidden debt" held by their LGFVs. This is debt owed by the vehicles but which is recognized as a liability by the local governments.
Why It Matters
The program will cut hidden debt held by LGFVs to about RMB2 trillion by 2028, from RMB14.3 trillion as of end-2023. This would make the obligations underlying China's ballooning LGFV debt almost fully transparent. By swapping the hidden debt with issuance of special-purpose bonds, local governments will somewhat cut funding costs. Moreover, the looming end to hidden debt will bring more discipline to the financial management of local governments.
However, LGFVs' corporate debt is a much bigger problem, and this program won't fix that issue. This is debt borrowed by the entity for commercial purposes. It represents 70%-plus of their debt stock, according to our estimates referencing data from Wind.
LGFVs' debt stock has more than doubled over the past five years as entities struggle with sluggish returns, high interest costs, and a shaky transition to a more commercial focus. Governments will be increasingly reluctant to provide direct support for these debts if an entity became distressed, in our view.
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What Comes Next
The winding down of hidden debt may mark the end of future debt swaps. LGFVs will need to assume the full responsibility of servicing the corporate debt that remains, and investors will focus more on their fundamentals when they borrow (see "China Brief: LGFVs Face Credit Differentiation As Transition Deadline Looms," Oct. 17, 2024).
For now the fundamentals largely haven't improved: LGFVs' debt increases are outpacing revenue gains by a large margin. Indeed, the growth in their corporate debt has more than offset the reduction in hidden debt.
We see temporary benefit but pressure is building. Despite the interest savings derived by swapping away the hidden debt, LGFVs' corporate debt will remain a heavy burden. The entities new mandate to be more commercially focused may require greater investment, but most are still a long way from becoming more financially self-sustained.
Background In Brief
In 2018, Beijing directed local governments to gradually settle the hidden debt raised by LGFVs. The directive was matched with several rounds of quotas allocated to local governments to issue bonds. The governments used the funds to repay this debt, as an acknowledgement that much of this money was used to build infrastructure for the local government.
However, LGFV debt has continued to rise quickly since then. Entities still need to invest, and they need to pay substantial interest.
Editor: Jasper Moiseiwitsch
Related Research
- China Brief: More Transparency Means More Official Debt For Local Governments, Nov. 12, 2024
- China Brief: LGFVs Face Credit Differentiation As Transition Deadline Looms, Oct. 17, 2024
- China's Latest Fix For Local Governments Could Turn Out To Be Debt Relief—Or More Burden, Oct. 15, 2024
- Your Three Minutes In China LGFV Financing: Offshore Bonds Are A Costly Lifeline, Sept. 23, 2024
- Your Three Minutes In China's LGFV Debt Resolution: Buying Time Is Buying Bad Habits, Sept. 5, 2024
- Credit FAQ: Is It Working? China's LGFV Debt De-Risk Program One Year On, July 25, 2024
- China's Local Governments: Capacity To Support SOEs Will Be Tighter For Longer, July 8, 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
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 Contacts: | Christopher Yip, Hong Kong + 852 2533 3593; christopher.yip@spglobal.com |
| Chen Guo, Hong Kong 25328063; chen.guo@spglobal.com |
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