China has faced many economic problems this year, from deflation and record youth unemployment to a property crisis.
But now, an even more worrisome threat is emerging: the colossal hidden debt of China’s local governments.
Some estimates put the liabilities of China’s local financing vehicles close to $10 trillion.
For some time now, markets have been buffeted almost on a daily basis by gloomy economic news filtering out of China.
The world’s second-largest economy is grappling with a raft of economic troubles — ranging from deflation to record youth unemployment, and a deepening property crisis — and its much-anticipated post-pandemic rebound has failed to materialize.
China’s mounting economic woes prompted US President Joe Biden to call the Asian economy a “ticking time bomb”.
And now, a lesser-known, but no less ominous, economic threat is rearing its head: China’s colossal hidden-debt problem.
This mainly refers to a mountain of liabilities accumulated by the country’s local governments, mostly to fund regional infrastructure projects such as building roads and bridges. An analysis by the Chinese media outlet Caixin Global estimated the outstanding obligations of the so-called local government financing vehicles, or LGFVs, at close to a staggering $10 trillion.
The Chinese government deems such debt a form of off-the-books lending and as such, the market is opaque. Here, Insider demystifies the shadow sector and explains the significance of LGFVs to the wider Chinese economy.
What are China’s LGFVs?
These funding bodies were set up by China to facilitate financing for regional infrastructure projects. Originally established to support infrastructure projects such as highways, airports, and energy installations, the LGFVs were designed to provide funding outside of the official government constraints.
The notion of “hidden debt” was defined by China’s State Council in 2018 as any borrowing that does not form a part of on-budget government spending – in essence, off-the-books financing.
The LGFV sector has grown exponentially since the 2008 global financial crisis, when the Chinese government made efforts to ensure that the nation’s infrastructure and public services segments expand fast enough to sustain its remarkable economic growth, according to Bloomberg.
Figures from Bloomberg and the International Monetary Fund estimate the total value of LGFV debt as more than $9 trillion – not far from the Caixin assessment. The local governments’ bonds alone total at about $2 trillion, and any defaults would rock the Asian nation’s $60 trillion financial system, according to Bloomberg.
In 2023, the LGFVs’ hidden debt climbed above 50% of China’s GDP for the first time, IMF data show.
Why does this matter?
For months, China’s local administrations have struggled to turn their financing vehicles profitable – increasing pressure on the national government to prop up the ailing sector via costly interventions.
As risks tied to the sector mount, banks are unwilling to lend more, investors are turning their backs on bonds, and viable projects are harder to come by, according to several anonymous employees interviewed by Bloomberg.
As a result, the local governments have been struggling to generate enough income or raise funding to meet the costs of servicing their debt.
“The most important variable impacting China’s economic growth over the next two years will be the success or failure of local government debt restructuring,” Logan Wright, head of China markets research at Rhodium Group, told Bloomberg.
But Beijing has so far refrained from intervening in the sector, in a bid to encourage self-sufficiency.
Echoes of the property crisis
Although none of the LGFVs have actually defaulted on their debt yet, the mounting stress in the sector echoes the crisis in China’s real-estate industry, which began in 2021 and has reverberated around global markets ever since.
“A collapse in local government investment would be comparable to the economic impact of the crisis in the property market,” Wright told Bloomberg.
China’s enormous property sector accounts for about 30% of the country’s overall output. Headwinds faced by the sector include heavy debt burdens and sluggish demand for new properties. This was a contributing factor in stunting the nation’s second-quarter GDP growth, which came in at 6.3%, below forecasts of up to 7.1%.
Indeed, any turmoil originating from China’s mountainous hidden debt would send shockwaves across the global economy.
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