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Is China Starting to Pay Off Their Hidden Debt Bomb?

Hidden Debt
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EDITOR NOTE: China’s economy is rebounding as local governments in the secretive state are using the economic uptick in the country to pay down so-called “hidden debt,” or local municipality debt that is kept off their balance sheets. The mandate from the state to pay down these debts is considered a national security issue in China, so the provinces are dealing with it urgently. The result is that China is strengthening its economic footing and speeding up its pandemic recovery. This will put the nation in a perfect position to take advantage of an economic crash in the U.S. driven by the devaluation of the U.S. dollar, which could come as soon as September 30 when the IMF may knock the U.S. dollar from its perch, as the world’s reserve currency. 

(Bloomberg) -- China could be making inroads in a long-standing battle to deal with local governments’ so-called “hidden-debt” as the economy’s rebound gives officials room to focus on tackling financial risks.

An analysis of local governments’ finances shows a difference of 668 billion yuan ($103 billion) between the amount of refinancing bonds sold in the first half of the year to roll over maturing debt and the amount of bonds repaid.

That implies cities and provinces may have used some of the proceeds to repay off-balance sheet debt, according to Robin Xing, chief China economist at Morgan Stanley in Hong Kong.

It “should make a positive contribution to the economy,” he said, helping to increase the transparency of government financing, reduce government funding costs and lower financial risks in the system.

Local authorities issued 1.9 trillion yuan of refinancing bonds in the six-month period, while only repaying 1.2 trillion yuan in official bonds, data from the Ministry of Finance last month showed.

“Hidden debt” refers to funds raised by government-related entities, like local-government financing vehicles, to pay for infrastructure spending and other public projects. The debt raised is kept off the balance sheets of local authorities, yet carries an implicit government guarantee of repayment.

A researcher at a state-linked think tank estimated the debt pile may have reached 14.8 trillion yuan last year.

Public Finances

The plan to reduce the debt dates back to 2018, but was only rolled out on a large scale this year after being delayed due to the pandemic, according to Zhang Yiqun, a member of the Society of Public Finance of China.

“The government is keeping a low profile but is determined, and local authorities are quietly making efforts” to deal with it, he said.

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Policy makers see less urgency in stimulating economic growth with debt-fueled investment this year as the economy recovers from the pandemic. Instead they’re taking advantage of that rebound to try and consolidate public finances, with top leaders vowing to stabilize the debt ratio in the economy and lower the ratio of government debt.

China’s macro leverage ratio, or total debt as a percentage of gross domestic product, fell to 264% at the end of the second quarter from 269% at the end of 2020, according to data compiled by Bloomberg. The biggest drop came from the corporate sector, which includes local government financing vehicles.

National Security Risk

The hidden debt problem is seen as so serious that the government this year called it a national security risk and ordered officials to deal with it by paying down debt or bring it onto the balance sheets of local authorities. In response, some provinces, cities and counties across the country have started publishing their repayment or refinancing plans.

In Shaanxi province, authorities included tackling hidden debt as a criteria to evaluate officials’ performance from this year, while Guizhou province said it had resolved 33.7 billion yuan of off-balance sheet debt in the first six months of 2021. Shenzhen city, China’s technology hub, pledged to clear all its hidden debt in 2021.

Pressure to resolve the issue can be seen in comments from China’s top leadership this year calling on senior local officials to be held accountable for any outbreaks of financial risks in their regions. They stressed the importance of that rule again at a meeting in late July.

On Wednesday, the People’s Bank of China stressed the need to speed up resolution of the issue, vowing to accelerate the reform of local government financing vehicles and prevent the risks of hidden debt from spreading further.

Local governments are banned from raising funds via corporate bonds, providing guarantees for corporate bond issuances or paying off company debt, according to a statement issued by the central bank. Relevant parties should ensure that “whoever borrows money pays it off at their own risk,” the central bank said, calling on local governments to “guard against hidden debt risks.”

However, dealing with the problem hastily may lead to liquidity risks, according to Zhao Quanhou, a local government debt researcher at the Chinese Academy of Fiscal Science. Some leeway is needed, he wrote in a paper in March, suggesting local governments be allowed to sell more refinancing bonds to swap the hidden debt with on-budget bonds carrying longer maturity dates and lower yields.

Original post from CA Finance

All articles are provided as a third party analysis and do not necessarily reflect the explicit views of GSI Exchange and should not be construed as financial advice.

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