China launched a Rmb6trn (US$838bn) debt swap programme to tackle local government "hidden debt" on November 8, the latest iteration and the largest amount ever for such a programme. But market participants said it is far from sufficient to fundamentally solve local government financial vehicles' debt problems.
The new programme is aimed at reducing local governments’ repayment pressure by allowing them to issue longer-tenor and lower-coupon special purpose refinancing bonds to repay LGFVs’ high-cost, shorter-tenor hidden debt. It was first mentioned by the finance ministry in early October, when officials said the scheme would be "the largest in recent years", without disclosing the exact amount.
LGFVs are special funding entities set up by local governments and owe the majority of local government debt, but the divide between an LGFV and a state-owned company is never clear. LGFV debt does not go on local governments' balance sheets, but many of the businesses are not run on a commercial basis and are only able to raise funding because investors believe they benefit from implicit support from their local governments.
China has rolled out a number of measures including extensions and debt swaps since 2018 to tackle hidden debt. The special-purpose refinancing bond scheme was first launched last year as part of a new policy package and Rmb1.4trn and Rmb1.2trn of those bonds were sold in 2023 and so far this year, respectively.
In addition to the debt swap programme, the central government has assigned a Rmb4trn special-purpose bond quota to be used onshore over the next five years for refinancing hidden debt. It also allowed Rmb2trn of hidden debt from its shanty town redevelopment scheme to be repaid after 2028, the initial deadline that China set to clear all local governments' hidden debt.
China claims that the new package will reduce the hidden debt by the 2028 deadline from Rmb14.3trn to Rmb2.3trn, which can then be "absorbed by local governments' own efforts”, said finance minister Lan Fo'an at a press briefing on November 8.
Despite the support for LGFVs, the lack of other simultaneous measures was a disappointment, CreditSights analysts wrote on Monday. The government did not say how much it plans to raise from central government bonds next year or reveal other details. Nor did it announce any stimulus plan to boost consumption or the property sector, which analysts had been expecting.
The new debt swap programme is more likely to boost domestic market sentiment than fundamentally solve LGFVs’ debt problems, as the amount only accounts for a small fraction of the total debt.
“The main purpose of the basket of new measures is to mitigate systemic risk. The total amount of LGFV debt is huge, and risks can spread to other areas including financial institutions and their associated suppliers, if mismanaged. This is crucial to China’s goal of maintaining financial stability, especially given that the economy is facing challenges on multiple fronts now,” said Wenyin Huang, a credit analyst at S&P.
The definitions of both hidden debt and LGFVs are vague, but the latest announcement was the first time the government disclosed the outstanding amount of the debt. Wind, a Chinese data provider, shows LGFVs' overall debt level at the end of 2023 was Rmb38trn, while the International Monetary Fund estimated the amount at Rmb66trn.
Despite official pressure to clear hidden debts, LGFVs have kept borrowing onshore and offshore. Refinancing bonds have been sold to cover both principal and interest payments, and new bonds have been raised as “operating debt” for new capital expenditure.
Last year, the central government specified that for LGFVs to be counted as state-owned companies at least 70% of their total assets and income should come from commercialised operating businesses, and less than 50% of profit from government subsidies.
Many LGFVs have added commodities trading businesses to claim they have become commercialised operating entities and should no longer be counted as LGFVs, said bankers. These businesses usually handle trades between just a few other LGFVs and state-owned companies, but generate enough activity to boost cashflow and income numbers.
Once they are no long counted as LGFVs, they will be allowed to raise new debt, which LGFVs have been banned from since 2018. Improving earnings by adding trading businesses also gives a better access to other funding channels, including bank loans, said analysts.
In addition to the relatively small size of the new debt swap programme, the plan only transfers the debt burden from LGFVs to local governments, which have limited resources as China struggles to revive its economy and the real estate crisis continues.
“The debt swap programme can alleviate LGFVs' debt refinancing pressure over the next few years as the provincial governments will issue special purpose bonds to substitute LGFVs’ hidden debt,” said Samuel Kwok, head of APAC international public finance at Fitch. “However, this could further pressure local governments’ flexibility on expenditures, considering the coupon and principal repayment needs to be paid out of the fiscal budget.”
Some interpret the new policies as a sign Beijing will continue to support LGFVs until 2028, with a question mark beyond that. Since the ministry of finance first indicated in early October that support was on the way, some LGFVs have taken advantage of the favourable sentiment to issue short-term debt.
"With expectations for governments’ financial support for LGFVs by the end of 2028, there’s been an increased amount of bonds issued at a shortened term recently, which will add to the refinancing pressure for LGFVs," said Laura Li, credit analyst at S&P.