MNI:China To Launch Debt Swaps To Address Implicit Liabilities

China is set to launch a swaps scheme for debt-laden local governments to move up to CNY1.5 trillion of off-balance-sheet liabilities onto their books with extended maturities and lower interest rates, while guiding state-owned banks to support debt restructuring, policy advisors and market analysts told MNI.

The Ministry of Finance will soon allocate quotas for special refinancing bonds to different regions to swap out hidden debts after local governments reported the scale of implicit liabilities in July, said Zhang Yiqun, director at a fiscal studies institute affiliated with Jilin province’s finance department.

Zhang did not provide details of the size of the programme, which reportedly could refinance about CNY1.5 trillion raised through local government financing vehicles (LGFVs). The ministry did not respond to a request for comment. The total amount of implicit debts could be as much as CNY60 trillion, according to ANBOUND think tank Analyst Wei Hongxu.

Another key part of the Politburo’s “basket of plans” to address local government indebtedness announced in July may involve major state-owned and policy banks assuming some implicit debts, Zhang continued. This would also end any chance of a central-government bailout, which would have represented a moral hazard for authorities, he added.

Banks may need to surrender profits by allowing debt rollovers with interest rates fluctuating amid the low-rate environment, Zhang said.

The People’s Bank of China may also use a special purpose vehicle (SPV) to inject liquidity into local banks to support the sale of refinancing bonds, said Ming Ming, chief economist at CITIC Securities.

DEBT SWAPS

Refinancing may not reduce the overall volume of debt, but it will give some indebted municipal- and county-level governments room to move, allowing provincial governments to consolidate debts, said Zhang. This would fall in line with the central government's principle, which states local governments should "take care of their own kids," he added. Zhang noted many of these liabilities were short-term borrowings with relatively high rates over 5%, while the average refinancing rate would be about 3% for maturities of 10 years or longer.

Short-term borrowing by district and county-level government financing vehicles soared 77.2% in the first half of 2020 before restrictions came into force in 2021, Ming said. Sluggish land-sale revenues amid the ailing property market are making it still harder for governments to cope with repayments of both LGFV debt and budgeted borrowing, he said.

Several provinces have swapped debt since 2020, but this now looks set to roll out nationwide, said Wei. As of 2022, CNY1.13 trillion in refinancing bonds were issued to “repay existing debt,” a change in terminology from the previously declared purpose of “repaying the principal of maturing bonds,” he said.

While the refinancing programme will tap into the unused bond quota from previous years and not exceed the statutory debt ceiling of CNY37.6 trillion as of 2022, it will still leave room for CNY2.6 trillion at most, according to Zhang.

Curbing hidden debt in the long term will require a raft of reforms such as debt-restraint mechanisms, boosting local government income while transferring some spending to the national level, commercialisation of financing vehicles, and increasing transparency and use of asset securitisation, Wei said.