China’s next debt crisis will be municipal

Men work on the construction site of the Beijing Xishan Palace apartment complex developed by Kaisa Group Holdings Ltd in Beijing, China on November 5, 2021. REUTERS / Thomas Peter

HONG KONG, Jan. 10 (Reuters Breakingviews) – On the southern bank of the Amur River that runs along the Russian border is one of China’s most affordable real estate markets. While an average two-bedroom apartment in Beijing can cost $ 1 million, investors can buy one in Hegang City for $ 10,000. Dependent almost entirely on coal mining, Hegang’s economy has been on the ropes for years. The pandemic seemed to push her to the limit. On December 23, local authorities announced that the city had frozen hiring and start of tax restructuring. It may be a first for China, but it probably won’t be the last.

While coastal provinces with strong export sectors have weathered the Covid-19 epidemic relatively well, local governments in the interior have come under heavy economic pressure. This was only made worse by Beijing’s decision to curb the real estate market. Not only has this led to homebuilders like Evergrande registering spectacular defaults, but it has depressed land sales, which on average contribute a third of cities’ tax revenues.

This means that even if developers default on bonds and trade credit and leave projects half-finished, China’s infamous army of local government finance vehicles could start to go bankrupt afterwards. An April state cabinet document suggested dysfunctional people should be allowed to go bankrupt. Their debt stock stood at $ 8 trillion at the end of 2020, Goldman Sachs estimated, equivalent to about half of China’s gross domestic product; Last year, they also replaced real estate developers as China’s biggest debt issuers overseas, with $ 31 billion in dollar bonds maturing in 2022.

LGFVs are a political oddity. They were invented, more or less, during the 2008 global financial crisis to allow authorities to bypass a central ban on direct borrowing by local governments, allowing localities to quickly get into debt for the stimulus. Today, they exist in a political gray area, created by and for official use but not technically guaranteed. Many of them have assets of questionable quality: roads to nowhere, empty airports. Provincial bond market reforms in 2015 were supposed to make them unnecessary, but they still exist, and many are heavily involved in primary land development before plots are sold to developers, making them direct victims of blocked deals. and price cooling. Much of their debt has been repackaged into wealth management products sold to ordinary people. They are also big borrowers from small banks.

Now land sales are expected to fall another 20% this year after a bruise in 2021, according to S&P Global Ratings. Yet despite Beijing’s recent tolerance for SOE failures, and despite the obvious lack of profitability and questionable governance of many LGFVs, some investors remain confident that they will be protected. Local rating agencies assigned investment ratings to those with very poor credit profiles, a November analysis from CreditSights showed.

As with real estate developer Shimao Group (0813.HK), which was classified as an investment until it suddenly began to default in January, the risk is less that rotten high-yielding LGFV bonds fall, but that low-yield bonds issues from rich regions are also poorly valued. After all, it is getting harder and harder to throw the box as new Covid-19 epidemics erupt from Xian to Tianjin. In Lanzhou, capital of Gansu province, 14 billion yuan ($ 2.2 billion) of LGFV bonds mature this year, equivalent to nearly half of the city’s tax revenue in 2021, per S&P. Regulators are capping national LGFV bond issuances and preventing those in poorer regions from participating, Chinese media reported, which will make it harder to roll over existing debt. Some will try to dump assets, but it might not be easy.

As with real estate, the question arises as to how hard Beijing can be on poorer parts of the country as the economy at large falters. If the central government is to stimulate growth, it must rely on cities to do their part. Some have the ability to raise funds through bonds targeted specifically for infrastructure spending, but others will need a lifeline just to stay afloat. Either way, investors and lenders will need to be careful.

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NEWS CONTEXT

– Land sales measured by area fell 17% year-on-year in 2021 in 300 major Chinese cities, consulting firm China Index Academy said in a report on Jan.6. Their total value fell 9% year-on-year.

Editing by Pete Sweeney and Katrina Hamlin

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