China has told state-owned banks to roll over existing local government debt with longer-term loans at lower interest rates, two sources with knowledge of the matter said, as part of Beijing’s efforts to reduce debt risks in a faltering economy.
Debt-laden municipalities represent a major risk to the world’s second-largest economy and its financial stability, economists say, amid a deepening property crisis, years of over-investment in infrastructure and huge bills to contain the COVID-19 pandemic.
Part of that is debt issued by local government financing vehicles (LGFVs), which cities use to raise money for infrastructure projects, often at the urging of the central government when it needs to boost economic growth. Empty coffers could make it harder for Beijing to kickstart a sputtering economic recovery.
Loans that were due in 2024 or before will be categorized as “normal” instead of non-performing if they overdue, and that won’t affect banks’ performance evaluations, one of the sources said. Reuters is reporting these measures for banks to defuse local debt risks for the first time.
To ensure banks do not incur heavy losses from the debt restructuring, interest rates on rolled over loans should not be below China’s Treasury bond rates, said one source, adding that loan terms should not exceed 10 years. China’s benchmark 10-year government bond is now yielding around 2.7%, while the benchmark one-year loan prime rate is 3.45%.
The two sources declined to be identified as the policies were confidential.
“The borrowing costs of LGFVs’ loans are usually about 4%, and in some regions and cases the costs could be even higher at about 5% to 8%,” said a banker, who declined to be identified as he is not authorized to speak to media.
“A large-scale loan extension and interest rate reduction will deal a heavy blow to banks’ operations,” he said.
Despite the mounting local fiscal mess, China’s central government has taken a cautious stance on resolving the debt issues to avoid risks of moral hazard: Investors could be encouraged to take even greater risks if they assume Beijing will always come to the rescue of local governments or state companies.
China’s deepening property crisis has added to the pressure on municipalities, with developers in no shape to buy more land, traditionally a key source of local revenue. Since the sector’s debt crisis unfolded in mid-2021, companies accounting for 40% of Chinese home sales have defaulted, most of them private developers.
The People’s Bank of China (PBOC) and the National Financial Regulatory Administration didn’t immediately reply to Reuters’ request for comments.
MAJOR RISKS
China’s Politburo, a top decision-making body of the ruling Communist Party, said in late July said it would announce a basket of measures to reduce local government debt risks, but no detailed plans have been officially unveiled yet.
Gradually paying off total local government debt over 20 years would require annual payments of 6.5 trillion yuan, analysts at ANZ Research said in a note last week. That’s larger than China’s estimated annual nominal GDP growth over the next decade, they said.
The central bank said it will prioritize resolving debt risks in 12 regions identified as “high risk”, including Tianjin city, Guizhou province and Guangxi province, with a focus on open market bonds and non-standard debt products due this year and next year, the sources said.
Banks are being encouraged to issue new loans to LGFVs to repay bonds and non-standard debt, the sources said.
And, Chinese investors are rushing to buy bonds of LGFVs, including from the riskiest issuers, as Beijing’s attempts to reduce local debt risks encourages them to bet on an implicit government guarantee.
DEBT PAYMENT CLIFF
LGFVs face significant bond maturity pressure in 2023 and the first half of 2024, according to a research note by UBS. Over 2.1 trillion yuan LGFV bonds matured in the first half of 2023, and another 1.75 trillion yuan in the second half of this year and 1.69 trillion yuan in the first half of 2024, the highest maturity pressure in history, the note said.
Additionally, the PBOC will set up an emergency tool with banks to offer loans to LGFVs to solve any short-term liquidity stress, the two sources said. LGFVs will need to repay the loans within two years, a second source said.
Financial news outlet Caixin first reported the central bank’s emergency liquidity tool in August.
In the 12 high-risk regions, some local governments will need to pledge or transfer part of their stakes in local state-owned companies to banks in exchange for assistance from banks to roll over loans, the second source said.
Last year, a Chinese government financing unit in southwestern Guizhou province extended loans worth $2.3 billion by 20 years, which adjusted interest rates to between 3% and 4.5% per year.
