Commentary on Political Economy

Wednesday, 9 December 2020



Chinese state investors sound alarm on cash crunch after defaults

The credit crisis facing LGFVs could raise concerns that defaults at debt-laden SOEs are spilling over into other parts of the economy © Reuters

Chinese government entities responsible for funding hundreds of billions of dollars in infrastructure projects are struggling to raise cash after a series of defaults by state groups rocked the country’s credit markets.

Executives from several local government finance vehicles (LGFVs) have told the Financial Times that they have abandoned bond sales or loan applications after debt-saddled state-owned enterprises, led by Yongcheng Coal & Electricity Holding Group, defaulted in November. Other LGFVs are paying much higher rates of interest to borrow.

The credit crunch facing LGFVs, which are responsible for funnelling cash to China’s local governments, has raised concerns that defaults at state-owned enterprises are spilling over into other parts of an economy whose recovery from coronavirus has been supported by infrastructure spending.

“LGFVs are one of the most important tools Chinese local governments can employ to achieve their policy goals such as boosting investment and creating jobs,” said Dan Wang, chief economist at Hang Seng Bank China. “Numerous projects could be stalled if LGFVs lose access to credit.”

While global capital inflows into China's bond market have picked up considerably in recent years, most western investors are focused on bonds backed by China's central government or policy banks. The problem with LGFVs, one of the biggest components of China's bond markets, will undermine Beijing's efforts to attract foreign capital into its capital markets.

Many Chinese cities and provinces rely on LGFVs to raise capital on their behalf to get around official restrictions on taking on leverage. According to Ms Wang, they have been the main contributor to China’s rapidly growing debt burden.

According to the Institute of International Finance, China's total debt — household, government, financial and non-financial corporate — to GDP ratio hit 335 per cent in the second quarter of 2020, up from 318 per cent in the first quarter of this year.

“We are the biggest creditor to local governments and the biggest debtor to China’s financial system,” said an executive at Hanjiang Urban Construction Development Co, an LGFV based in the eastern province of Jiangsu, who was not authorised to speak to the media.

Investors don’t see us as a viable business when government support is gone

Executive at Chengfa Investment Group

The defaults at SOEs have also shattered a long-running perception among investors that authorities in China will always step in to rescue financially imperilled state groups.

“We will run into trouble when authorities are too stretched to bail us out,” the executive added.

In 2019, LGFV borrowing accounted for almost half of China’s new business loans and a third of corporate bond issuance, according to official data.

Figures also show that LGFVs, which collectively are China’s biggest spender on construction projects, sold a record Rmb3.4tn in bonds in the first three-quarters of this year, a 31 per cent jump from a year earlier.

These bonds have historically benefited from strong investor demand based on their high credit ratings, even as projects such as roads and bridges have suffered from razor-thin profitability and lack of cash flow.

However, total LGFV bond issuance has dropped 14 per cent year on year since Yongcheng reneged on its debt repayments nearly a month ago, according to information provider Wind.

“Investors don’t see us as a viable business when government support is gone,” said an executive at Chengfa Investment Group, an LGFV based in the eastern Chinese province of Shandong. The firm last week dropped a plan to issue an Rmb820m bond owing to “market turmoil”.

Bank loans have also dried up for many struggling LGFVs. An executive at Zhongyuan Bank, a creditor to multiple government-controlled investment platforms, said the lender had “significantly” tightened standards for LGFV borrowers to control its risk.

“We used to work with any state-backed platforms regardless of their fundamentals,” said the executive. “Now we pay close attention to their leverage ratio and sources of debt repayment before approving or turning down their loan requests.”

LGFVs that are still able to borrow are having to pay more for the privilege, which in itself could exacerbate financial stress.

Public records show that, on average, the yields on new bonds issued by LGFVs have jumped to 4.8 per cent since Yongcheng defaulted. That compares with less than 4 per cent in the first nine months of the year.

That has made it much more difficult and expensive for LGFVs, many of which are lumbered with high levels of leverage, to roll over their existing debts.

“If we don’t borrow now, we will have trouble servicing debt due next month,” said an executive at Yan’an Urban Construction Group.

The LGFV has had to stump up an extra 180 basis points on average to borrow from the bond markets over the past nine months.

“If we do take credit at a higher cost, we will have a hard time pay it off in the coming years,” the executive added.

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