MNI Analysis:China Local Debt Curbs To Rise, But At What Cost?

--Loopholes Could Keep Local Debt Circulating

--Some See Concerns As Overblown

     BEIJING (MNI) - The Chinese government will continue its attempts to clamp

down on the growth of local government debt, but the unresolved issue of how to

adequately finance local government projects to maintain stable growth means

that implementation of the debt curbs is likely to fall short of expectations,

experts told MNI. 

     As President Xi Jinping and other government officials stressed during the

19th Communist Party Congress last month, how the world's second-largest economy

maintains economic growth while taming the nation's rapidly rising debt,

particularly local government debt, remains a troublesome question.

     Xin Liu, director of sovereign and international public finance ratings at

ratings agency S&P Global, said in an interview with MNI that local government

debt is still growing, but the growth "may be slightly slower than before."

     "In general, we don't see that local governments are likely to deleverage

anytime soon because there are a lot of LGFVs that are still doing financing for

local governments," she said, referring to local government financing vehicles,

which are in theory prohibited from raising off-budget funds for local

governments.

     China's rapid credit growth has supported the infrastructure building and

real estate construction that have been the main drivers of GDP growth over the

past decade. According to the International Monetary Fund, China's credit growth

averaged 20% per year from 2009 to 2015, much higher than its annual nominal GDP

growth.

     Local governments finance on average about 80% of their expenditures but

only receive around 50% of tax revenues collected locally, with the other 50%

handed over to the central government. 

     They thus struggle to find extra financing channels to fill the gap, often

turning to land sales or LGFV funding -- methods the central government is

trying to cut back on or block. 

     In recent years, the central government has frequently issued new policies

to speed up deleveraging at the local level. At the end of 2014, the "No. 43

document" issued by the State Council mandated a strict delineation between

corporate debt and local government debt, and also prohibited local governments

from obtaining funding through LGFVs -- companies that are usually set up by the

local government to do off-budget financing, mostly for infrastructure projects.

     During the period of rapid growth after 2008, LGFVs provided much of the

funding for local governments, with the financing being categorized as corporate

debt, leading to an abnormally high -- and disguised -- leverage rate in the

corporate sector.

     As the central government's regulatory push has intensified, implementation

of debt restrictions at the local level has often been at odds with the

principle set by the top level. Local governments lack motivation to deleverage

because they still have a strong incentive to develop their regional economies

under pressure from Beijing and in order for local officials to climb the

political ladder.

     "On the one hand, central government policy will affect the support channel

that local governments have traditionally gotten from their LGFVs" Liu said.

"But I think it comes down to how enforceable these [central government]

measures will be and how strictly they are going to be implemented everywhere."

     Loopholes in the system will continue to allow invisible local government

debt to increase with the help of LGFVs, she said.

     "I don't see them [policy measures] as a fundamental change that shifts the

direction of how local governments actually get support from their LGFVs," Liu

told MNI.

     Assessing Chinese local government debt using much broader criteria than

Chinese authorities and even other financial institutions, S&P Global has said

China's rapid credit growth would impede its economic growth and increase

financial risks. The ratings agency lowered its long-termed sovereign credit

ratings on China to "A+" from "AA-" and the short-term rating to "A-1" from

"A-1+" in late September.

     However, Chen Long, an analyst with Gavekal Dragonomics, a Beijing-based

research firm focusing on China's macro-economy, told MNI that concerns about

local government debt are overblown.

     "More debt is not necessarily a bad thing, and less debt is not necessarily

a good thing," Chen said, noting that credit growth has helped power China's

robust economic growth in recent years.

     Given limitations on local government access to tax revenues, the surge in

local government debt was inevitable, he argued.

     "Local governments need to raise funds for some projects because they have

economic goals they need to accomplish," Chen said. "But some [funding] channels

could not be used, so they could only use this channel," he said, referring to

financing through LGFVs. 

     He pointed to the dilemma of whether the costs of China's huge investment

in infrastructure projects -- which are primarily at the local level, usually

take a long time to complete and have low investment returns -- should be

shouldered by the central government or tackled by local governments using

self-financing or funding through off-balance-sheet LGFVs.

     In any case, local government are not likely to enforce the policy

directives from the central government at the expense of a "full cut-off" or a

rapid deceleration of local investment because "development is still China's

core task," Chen said. 

     Pei Yonggang, chief ratings director at Beijing-based Golden Credit Rating,

one of China's major ratings companies, said in an interview with MNI that

central government measures to control local government debt have been

effective, but more controls are needed to prevent increasing risks.

     "There will be stricter rules for LGFV bond issuance, and invisible debt at

the local level will be curbed" with more controls, Pei predicted. 

     LGFVs need to be reformed according to rules of the market, Pei said,

noting that the current debt-paying methods of local governments are not

sustainable.

     China's 2015 budget law requires that local governments may only borrow

through central-government-approved bond issues, and that their debt accumulated

before 2015 can only be repaid via debt-for-bond swaps. Outstanding local

government debt had reached CNY15.4 trillion at the beginning of 2015, according

to a report by the State Council.

     The State Council announced last year that the outstanding pre-2015 local

government debt would be swapped within three years. Some CNY3.2 trillion was

swapped in 2015, CNY4.87 trillion in 2016, and CNY2.15 trillion in the first

three quarters this year, according to Securities Times. CNY4.12 trillion in

local government debt still needs to be swapped.

     Liu of S&P Global predicted China would complete its debt-for-bond swap

program roughly by the end of this year or early next year.

     The central government and local governments are trying to achieve a

delicate balance between curbing rapid growth of local government debt while

maintaining stable economic growth, Liu said.

     "The central government is open to slower growth, but they also want stable

growth," Liu told MNI, adding that it is hard to predict how much "slower"

Beijing is willing to see growth go.

     The central government's No. 89 document, issued in August, encourages

provincial governments to issue bonds backed by specific infrastructure

projects. That will continue to add new debt at the local level and drive

economic growth.

--MNI Beijing Bureau; +86 (10) 8532-5998; email: iris.ouyang@marketnews.com

--MNI Beijing Bureau; +86 (10) 8532-5998; email: vince.morkri@marketnews.com

[TOPICS: M$A$$$,M$Q$$$,MT$$$$,MGQ$$$]