The Panda in the room. "While coastal provinces with strong export sectors have weathered the Covid-19 outbreak relatively well, local governments in the interior have been under heavy economic stress. That was only aggravated by Beijing’s decision to rein in the real estate market. Not only has it driven homebuilders like Evergrande to log spectacular defaults, it has depressed the land sales that contribute an estimated one-third of cities’ fiscal revenue on average.
This means that even as developers default on bonds and trade credit, and leave projects half-finished, China’s infamous army of local government finance vehicles could start going belly up next. An April document from the state cabinet suggested dysfunctional ones should be allowed to go bankrupt. Their outstanding debt amounted to $8 trillion at the end of 2020, Goldman Sachs estimated, equivalent to around half of China's gross domestic product; last year they also replaced property developers as the biggest Chinese debt issuers offshore, with $31 billion of dollar bonds coming due in 2022.
Now land sales are forecast to fall another 20% this year after a bruising 2021, according to S&P Global Ratings. Yet despite Beijing’s recent tolerance of defaults by state-owned enterprises, and despite many LGFVs' obvious lack of profitability and dubious governance, some investors remain convinced they will be protected. Local ratings agencies have awarded investment grades to those with very weak credit profiles, a November analysis by CreditSights showed.
As with property developer Shimao Group (0813.HK), which was rated investment grade until it suddenly started to default in January read more , the risk is less that high-yielding, junk-rated LGFV bonds fall over, but that lower-yield issues from wealthy regions are mispriced too. It’s getting harder, after all, to kick the can down the road as renewed Covid-19 outbreaks flare up from Xi'an to Tianjin. In Lanzhou, capital of Gansu province, 14 billion yuan ($2.2 billion) of LGFV bonds are coming due this year, equivalent to almost half of the city’s 2021 fiscal revenue, per S&P. Regulators are capping LGFV domestic bond issuance and preventing those from poorer regions from participating, Chinese media have reported, which will make rolling over existing debt harder. Some will try to dump assets, but might not be easy.
As with real estate, there is a question about how tough Beijing can be on the poorest parts of the country as the wider economy wobbles. If the central government wants to stimulate growth, it must rely on cities and towns to do their part. Some do have the ability to raise funds via targeted bonds specifically for infrastructure spending, but others will need a lifeline just to stay afloat. Either way, investors and lenders will have to watch their step.
China’s next debt crisis will be municipal | Reuters
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