China’s Push to Clear Hidden Debt Likely to Benefit Weak Regions

China is getting serious about clearing the off-balance sheet debt of local governments, and weaker provinces are likely to benefit the most from the process.

(Bloomberg) — China is getting serious about clearing the off-balance sheet debt of local governments, and weaker provinces are likely to benefit the most from the process.

Zhang Wei, an analyst with Founder Securities Co., estimates that southwestern and northern provinces like Yunnan and Tianjin will likely be prioritized if China adopts a plan to reduce so-called hidden debt through bond swaps. Bloomberg News reported last month that officials are considering such a plan to help tackle a problem that’s become a major risk to economic growth and financial stability. 

The hidden debt comes mainly from local government financing vehicles, companies that have borrowed on behalf of local authorities and that carry out infrastructure spending on projects like roads and railways. There are no official figures for the size of LGFV debt, although the International Monetary Fund estimates it could be as high as $9 trillion.

Bloomberg News reported earlier that authorities are considering allowing local governments to sell bonds from their unused quota from previous years to pay down the hidden debt. More than 1 trillion yuan ($139 billion) of unused bond quota could be used, people familiar with the matter had said.

Shanghai Securities News on Thursday put the figure at 1.5 trillion yuan and said the bonds would be sold this year, citing an unidentified expert. The move will lower the interest rate on liabilities and give regions more time to repay their debt, the newspaper quoted the person as saying.

As of the end of 2022, Chinese provinces had a total of 2.59 trillion yuan in unused quota from previous years, according to Bloomberg calculations based on data from the Ministry of Finance. 

Weaker Provinces

Zhang suggested authorities will likely distribute bond quotas from financially stronger provinces to weaker areas. That will benefit regions like Yunan, Guizhou, Chongqing, Tianjin and Guangxi, regions where the borrowing costs on existing LGFV debt are high and much of it is maturing in the next couple years, he wrote in a note on Wednesday.

Shanghai, Jiangsu in the east, Beijing, Hebei in the north and Henan in central China have the highest amounts of unused bond quota among their peers, Zhang said. In general, the central government can take back 30% of unused quota from provinces and redistribute it among other regions, he said.

China used the debt-swap arrangement on a large scale in 2015-2018 when provinces were allowed to issue bonds on their own. In 2019, some counties in less developed regions were picked by the government to replace their hidden debt with bonds in a trial program to improve their financing ability. 

In late 2020, special local bonds for refinancing purposes were introduced, first to help weak areas reduce their off-balance sheet liabilities, and then used by rich areas including Beijing, Shanghai, and Guangdong in south China to clear hidden debt. Guangdong in 2021 became the first to claim it had successfully eliminated the debt.

Discussion about the debt swap increased after the Communist Party’s Politburo last week said a “holistic plan” will be put together to resolve the local debt problem. President Xi Jinping has previously described the issue as one of the “major economic and financial risks” facing China.

More than half of China’s 31 provinces have on-balance sheet debt that exceeds a threshold set by Beijing. That’s even before the LGFV debt is added.

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