China managed to bounce back from the global financial crisis and lead the world in economic growth thanks to a credit-fueled expansion by city and provincial governments across the country. They used vehicles known as local government financing platforms to issue bonds and borrow from banks.
Now that debt is starting to come due, testing the capacity of local governments to service several trillion yuan worth of outstanding bonds. The nation’s cooling economy, which is slowing the growth of local government revenues, will add to the financing strain. In coming months bond holders including state banks will likely have to choose to either roll over existing debts or push some entities into default.
The former choice is far more likely, analysts say, given close ties between China’s state-run financial institutions and governments eager for economic growth. Ministry of Finance officials told the National People’s Congress in March that the ministry would issue bonds this year to help local governments close an expected 350 billion yuan ($56 billion) gap between revenues and spending.
Nevertheless, bad-debt alarm bells have been sounded in recent months by other government agencies such as the State-owned Assets Supervision and Administration Commission, a powerful government agency that oversees all state-owned enterprises. In January SASAC‘s deputy director, Huang Shuhe, reportedly discussed rising risks for local government platforms with the State Council, China’s cabinet.
In March the China Banking Regulatory Commission (CBRC) ordered banks holding local government debt to stop lending to platforms with a debt-to-asset ratio above 80 percent. The agency also recommended that banks lend no more to platforms this year than in 2012 and cap their total outstanding debt, including bonds and loans, at the 2011 level of 9.1 trillion yuan.
Local government financing platforms have been around for years. They issue bonds to finance the construction of highways, subways, industrial parks and other projects. The pace of bond issuance accelerated rapidly after 2008, when the Ministry of Finance stopped requiring all government bond projects to first receive the ministry’s approval. Infrastructure spending helped the economy grow at an average annual rate of 9.6 percent between 2009 and 2011 and by 7.8 percent in 2012, according to the International Monetary Fund.
According to a recent report by Pengyuan Credit Rating Co., local government financing platforms issued 2.17 trillion yuan in bonds between 2008 and 2012. These bonds, which have maturities of five to seven years, represent a significant part of overall local government debt, which stood at 11.7 trillion yuan at the end of 2012, according to the Ministry of Finance.
The flow of bonds turned into a torrent last year, which explains why regulators have been trying to put a lid on issuance. Platforms issued a record 799 billion yuan of bonds in 2012, more than double the 348 billion yuan total of 2011, according to Pengyuan, a Beijing-based ratings firm whose clients include banks and local governments. A “moderate increase” is likely in 2013 although “it won’t even come close to the doubling” posted last year, says Liu Hongfang, Pengyuan’s chief analyst. He expects “steady growth” for platform borrowing for “at least the next decade.”
Until now the capacity of these borrowing vehicles to service their debts hasn’t been tested. Chinese banks, investment managers, insurance companies and private firms have been content to snap up platform bonds bearing interest rates of between 6 percent and 8.5 percent a year, says Liu. But as the amount of bonds reaching maturity grows larger, market attitudes could become less sanguine.
A potentially significant amount of the fresh platform borrowing in coming years will go toward paying off maturing bonds, says Liu. The firm estimates that about 30 percent of the 236 billion yuan of bonds issued in 2008 will reach maturity this year. That figure will rise sharply in coming years.
No one knows how many platforms will actually pay in full, or how many might borrow new money to pay old debt. Neither the central nor local governments regularly publicize platform debt data.
There are no statistics on the amount of bond debt that is effectively rolled over. In January the Financial Times estimated that banks rolled over about 3 trillion yuan in outstanding local government debt, including platform bonds, last year.
Banks typically support platforms whose infrastructure projects have central government backing, even if it means lending to a city whose ability to service those debts is questionable. If a project can’t generate enough commercial revenue or taxes, or a local government can’t sell enough state-owned land — a key revenue source for local authorities — cities and provinces can run into difficulties in meeting their debt obligations.
Although “only a few” local governments have had problems servicing their debts, the risk of bond defaults is real, insists Liu.
Economists have been warning of risks to the economy since the National Audit Office released the first-ever official data on local government debt back in 2010. It showed that 70 local governments, including 18 provinces, owed a total of 2.79 trillion yuan at the end of 2009. A year later the government auditor said total local debt had ballooned to 10.6 trillion yuan, of which 21.8 percent was in the form of bonds. It warned that governments might be borrowing beyond their means. Those figures prompted the CBRC to tighten its oversight of bank lending to platforms. In early 2012 SASAC went directly to some local government financing platforms and urged them to cut risk.
But as last year’s huge jump in platform issuance indicated, those warnings have had no noticeable impact so far.
Some analysts say fears about local government debts are overblown. A recent analysis by Sealand Securities Co. said most platform bonds are “inside the safety margin” and concluded that they pose “no systemic risk” to the Chinese economy.
Liu likewise views the risk as controllable. Notwithstanding the warnings from SASAC and the CBRC, Beijing continues to provide political support for local infrastructure projects. “Local governments have good credibility,” says Liu. “It’s pretty easy for them to borrow new money to pay old debt.”
