Commentary on Political Economy

Sunday, 3 January 2021



Chinese local government investment vehicles evade borrowing limits

Analysts warn that shifting assets on to the books of local investment companies to raise more money for infrastructure projects is unsustainable © Bloomberg

Regional governments across China are evading borrowing limits by transferring assets on to the books of local investment companies to lower their official debt-to-asset ratios, according to executives and officials.

The practice has allowed local government finance vehicles to raise more money for infrastructure and other construction projects. But analysts warn that many of the assets are of poor quality, setting the stage for a surge in bad debts after a wave of bond defaults at government-backed companies in recent weeks. 

“Many of our assets do not generate much economic value,” Liu Pengfei, president of Taiyuan Longcheng Development Investment, an LGFV in the northern city of Taiyuan, said at an investment conference last month. “The Taiyuan government gave them to us so we can meet [the debt-to-asset] requirements set by our creditor banks and bond investors.”

TLDI used to focus on infrastructure projects. Now, it is a large, diversified operator of everything from parking facilities to tourist attractions, many of which are barely staying afloat.

According to public records, the total assets of 960 large LGFVs that regularly disclose financial results rose 40 per cent over the past four years. Their revenues and net income, however, increased just 6 per cent and 4 per cent respectively.

The bigger we are, the more we can borrow

An executive at a Yan’an City Construction Investment Corp

“A Rmb100bn [$15.3bn] company won’t be less likely to default on debt than a Rmb10bn one just because of a difference in size,” said Bo Zhuang, chief China economist at TS Lombard, a research group.

The surge in acquisitions looks set to continue as local governments look to LGFVs to boost the economy in the wake of the coronavirus pandemic. The Shaanxi provincial government said in a statement in October that it would transfer “as many assets as possible” into LGFVs so they could double their borrowing over the next two years. The measure would “effectively eliminate government debt risks”, the government added.

“The bigger we are, the more we can borrow,” said an executive at Yan’an City Construction Investment Corp, another Shaanxi-based LGFV.

The executive said YCCIC has been given dozens of state-owned businesses by the Yan’an municipal government since 2018, ranging from hotels to water treatment plants. Most of them struggle to turn a profit.

Nevertheless, the executive added, YCCIC was able to borrow more because its bigger size had translated into a better credit rating, which was raised one notch to double A plus in October. Over the past two years, YCCIC’s outstanding bank loans have more than doubled.

Many local governments had previously given their LGFVs valuable land for free in order to boost their borrowing capacity. But the practice has been banned by the central government, forcing local governments to resort to transfers of lower quality assets.

Chinese banks, the biggest lenders to LGFVs, are comfortable lending to bigger government-owned investment companies even if their underlying asset quality is deteriorating.

“We have an obligation to support government-controlled enterprises as long as they meet the basic financing requirements,” an executive at Bank of Xi’an said.

Rating agencies, on which LGFVs rely to gain access to the bond market, are also generally supportive. An executive at China Chengxin Credit Rating Group, one of the country’s largest, said the company was paying more attention to total assets than profits or cash flow. “The injection of government-controlled entities, whether they are profitable or not, into LGFVs is a sign of state support,” said the official. “That’s a plus for their credit rating.”

Some investors, however, are not convinced that the LGFVs’ acquisition spree will make them less likely to default.

“The expansion of LGFVs’ balance sheets won’t make credit risks go away,” said Dave Wang, a Shanghai-based fund manager who specialises in buying LGFV debt. “They may break out at a later date, on a bigger scale.”

Some LGFV executives said they were aware of the potential risks as they seek to build more market-responsive businesses.

An executive at Jiangdong Holding, an LGFV in the central city of Ma’anshan, said his group had acquired two smaller peers and wanted to emulate Temasek, the Singaporean state-owned investment group, even if it could not match its return on capital for the foreseeable future.

“Temasek has enjoyed an annual investment return of 16 per cent for many years,” he said. “We would be happy with 1.5 per cent.”

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