Growing financial distress in regions across China is raising the risk of local governments defaulting on their bonds, as the nation presses on with its costly zero-Covid strategy.
The weakening of local government finances has been of growing concern in recent weeks, triggering questions about whether local Chinese authorities will need to cut back on spending in public services, and about the overall rising costs of keeping nationwide coronavirus-curbing measures in place.
Many of China’s local-level governments have been struggling with tight fiscal budgets for years. In recent weeks, Changshou district in the southwestern municipality of Chongqing, and Neijiang city in Sichuan province, started charging people to stay in centralised quarantine facilities that were previously funded entirely by the government.
In Changshou, non-local residents who stay in one of the quarantine centres are now being charged up to 300 yuan (US$40) per day, according to a notice posted on the government’s WeChat account on September 21.
There are exceptions, such as for doctors and students, but when the mandatory quarantine period lasts a week, an additional 2,100-yuan expense is simply unaffordable for some people.
China’s zero-Covid policy mandates mass screenings, lockdowns and lengthy quarantines. The policy has even pushed some local governments to transfer possibly “exposed” people to quarantine centres instead of allowing them to quarantine at home, as an extreme means to curb local infections.
There have also been reports of disruptions to public transport services in provinces such as Henan, Hunan and Guangdong due to financial troubles, and these problems reflect growing challenges facing some local governments, said Luo Zhiheng, chief macroeconomic analyst with the research institute of Yuekai Securities.
“This connects to everything, from drivers’ salaries to low-income groups’ ability to travel,” Luo said in a note last week. “The disruptions demonstrate that there are weaknesses in some local governments’ ability to safeguard public services.”
Between 2021 and 2025, roughly 3 trillion yuan (US$415 billion) worth of bonds sold by local government financing vehicles (LGFVs) will mature annually, and the repayment pressure has become increasingly significant, according to analysts.
LGFVs are off-balance platforms that have been hugely popular with local governments in China as the go-to source for borrowing, but disclosure of the use of funds is often poor.
On the evening of August 29, an LGFV in Gansu province, called the “City Development of Lanzhou”, made a last-minute dash to repay interest on a bond listed in the interbank market, after the Shanghai Clearing House announced earlier in the day that it had not received sufficient funds from the LGFV to meet its interest payment requirement. The delay in the interest payment immediately raised questions over the risks of a possible LGFV bond default in the listed market.
“LGFVs’ problems are set to worsen since their government owners won’t be able mobilise as many resources to support the vehicles in servicing debt,” S&P Global credit analyst said Laura Li in a note on September 5. “This is against the backdrop of plunging land sales, growing government expenditures related to Covid measures, and an economic slowdown in China.”
China’s growth has been slowing, and it is not expected to meet its annual target gross domestic product (GDP) of “around 5.5 per cent” this year. Beijing has pushed local governments to borrow at record rates to construct infrastructure projects, in a bid to boost local economies, and thereby the national economy.
S&P said the City Development of Lanzhou is a major LGFV engaged in urban redevelopment, utilities and bus services in Lanzhou, the provincial capital of Gansu. The company’s liquidity crunch has been simmering since the second half of last year, mainly because it’s been cut off from capital markets, the US rating agency said.
Luo with Yuekai Securities said local governments face a dilemma as revenue of some of the LGFVs is plummeting and they are struggling to meet debt payments.
“If [local governments] decide to intervene, their finances will be even worse. But if they don’t, it may affect the credit record of the regions and their ability to find funds again,” Luo said.
Local governments’ general budgetary revenue shrank 7.9 per cent in the first half of 2022, according to a report by US rating agency Moody’s Investors Services, driven by coronavirus-related disruptions and the nation’s large-scale, tax-rebate policy implemented in the second quarter.
Land sales fell by 31.4 per cent in the first half of the year, and Moody’s expects full-year land sales growth to remain in the “negative double digits”.
Logan Wright, an adjunct fellow with the Trustee Chair in Chinese Business and Economics at the Centre for Strategic and International Studies think tank in Washington, said that a bond default by an LGFV is “only a matter of time”, given local governments’ financial distress and declining land-sale revenues.
“Nowhere is the stress from the property sector more apparent than local government finances,” Logan said in a blog post on September 21.
“The period immediately following the 20th party congress this autumn may be particularly dangerous, given that newly appointed local officials will likely wait out the political season over the next two months before trying to extricate themselves from their predecessors’ debt starting in November,” Logan predicted.