China under pressure as infra debt payments come due

Local government financing vehicles used to fund infrastructure projects face bond maturity payments of $530bn between 2019 and 2021.

A report by S&P Global Ratings has pointed to a growing risk of default among China’s government-linked financing vehicles, which are mainly used to fund infrastructure projects, as they face bond payments of up to 3.8 trillion yuan ($533.3 billion; €483.7 billion) between 2019 and 2021.

“Some local government financing vehicles have been missing payments or have defaulted on some trust financing in recent months,” Gloria Lu, an analyst at the credit rating agency, told Infrastructure Investor.

She added that default risks were rising due to insufficient financial backing from local and regional governments, poor monitoring of LGFVs and growing reluctance among lenders to support weaker financing vehicles.

The report said Chinese local and regional administrations had used financing vehicles to borrow heavily from the market to finance “mostly unprofitable” infrastructure and social projects without including the debt on their balance sheets.

Quoting figures from financial data service provider Wind, S&P estimated that debt from these financial vehicles might amount to up to 33 trillion yuan.

According to the report, China’s central government favours transforming the hidden debt into corporate debt with longer maturities. However, the report added that commercial banks were only inclined to help vehicles backed by sound assets, “and that could be a small fraction of the total”. At the same time, S&P pointed out that most hidden debt was backing unprofitable projects that would not be able to attract interest from commercial banks.

“We believe the restructuring of LGFV debt might be a workable resolution, although it would probably only address the refinancing of some LGFV debt, not all,” Lu said. “Ultimately, for debt not restructured, LGFVs need the local and regional government owners’ support to help them weather the upcoming debt-maturity walls.”

Although local governments can increase their income through land sales, taxes, the issuance of additional bonds as a swap for hidden debt, or increased availability of other financial resources, these are not quick fixes. “It could take more than 10 years for regions with high off-budget debt to offload their burdens,” S&P said.

The report made it clear that a solution would be needed sooner rather than later: “If defaults or bankruptcies among high-profile LGFVs become epidemic, it would erode market confidence, tarnish government reputations, and destabilise the financial system.”

Boost to PPPs

The Chinese government has been trying in recent months to balance, on the one hand, the need to boost growth by promoting infrastructure projects and, on the other, its campaign to rein in hidden debt from local governments.

In June, Beijing eased restrictions on special-purpose bonds launched by local authorities, in a bid to attract private capital to the sector. Despite this, infrastructure investment grew by 4.1 percent during the first half of 2019, below the above-15 percent average achieved between 2014 and 2017 inclusive.

“We believe the government will make more efforts to pave the way for the use of more [local and regional government] special-purpose bonds, particularly as seed capital, to finance key infrastructure projects in China,” Lu said.

At the same time, the report said, the popularity of public-private partnerships was growing, as the government had banned local authorities from guaranteeing returns or the redemption of the principal from PPPs.

“PPPs will continue to grow in popularity, albeit at a steady, rather than explosive, pace,” Lu said. “In China, attracting more private capital into infrastructure projects is currently very challenging, and […] in many cases, the economics and business models of operating infrastructure projects are not attractive to private capital.”