China’s Ministry of Finance on Feb. 9 reported that as of the end of December 2021, the balance of local authority debt was about $4.81 trillion. Chinese authorities said it was within the approved limit.

In the article on Aug. 18, 2021, Bloomberg showed a difference between the amount of refinancing bonds sold in the first half of 2021 to roll over maturing debt, and the figure for bonds repaid was $103 billion. That indicates local authorities might have used some of the proceeds to repay off-balance-sheet debts.

According to a report by Kaiyuan Securities, as of mid-2020, the implicit debt of the country’s local authorities has reached $6.92 trillion, much higher than the $3.77 trillion of explicit debt. The two types of debt margins are close to 250%, far more than twice the warning line.

Many cities have high debt rates and higher hidden debts

Last October, Databao and Tencent Finance jointly released the “City Debt Ratio Ranking List,” indicating the survey counted 86 first-tier, new first-tier, and second-tier cities in China. These included Beijing, Shanghai, Guangzhou, Shenzhen, Kunming, Guiyang, and other cities. Among them, 85 cities have a debt ratio of more than 100% in 2020, and 75 cities have a debt ratio that has doubled from 2019.

The survey also said China’s local debt was about $4.05 trillion at the end of 2020.

However, the above official and survey data do not include “hidden” liabilities, of which urban investment bonds are the largest.

The hidden debt comprises funds obtained for infrastructure and other public projects by authorities with an implicit official promise of return. For example, provincial authorities sold bonds via Local Government Financing Vehicles (LGFVs) to obtain capital for increased expenditure without including it on their official balance sheets.

According to Bloomberg, on Sept. 9, 2021, the hidden debt of China’s local authorities surged from $2.5 trillion in 2013 to about $8.2 trillion at the end of 2020.

It was roughly 52% of China’s GDP and was more than the official outstanding regime debts.

Bloomberg calculations demonstrated that local authorities would have to repay a record-high $337 billion worth of LGFV bonds maturing in 2021.

As shown in the Ministry of Finance’s report, local authority bonds were due to repay the principal of $42 billion from January to December 2021. As a result, the interest paid by local government bonds was $146 billion. In December, the interest paid on local government bonds was $7 billion.

However, China doesn’t officially assess local-level hidden debt as it’s technically illegal. Therefore, it is challenging to deliver the exact figures, making various institutions launch different private estimates regarding China’s debt dilemma.

A senior researcher at the National Institution for Finance and Development, Liu Lei, said that the hidden debt could have led to more than $110 billion yearly in additional interest payments. That is because such borrowing is more expensive to service than government bonds. It also threatened China’s financial system stability as all types of financial institutions, including banks, brokerages, and trust funds, have raised money from such off-balance-sheet debts.

Debt Problems have accumulated for nearly 40 years

According to research information from the Open Source Securities Institute, since China’s reform and opening up, local authorities in the Communist Party of China have gradually dominated investment. Under a performance appraisal system that favors economic growth, local governments have invested heavily in debt to stimulate economic growth. In the 1980s, most Chinese provinces had already started to raise debts.

A 1994 Budget Law banned local authorities from raising debts. Since then, urban investment platforms and other “hidden conduits” have become the central financing bodies of local authorities in the Communist Party. After 2008, local debt nearly doubled in two years.

Since 2008, the number of LGFVs has increased rapidly. Estimates by Guangfa Securities are that 3,060 LGFVs sold debt in the public bond market by December 2021.

In 2015, the new Budget Law was implemented, allowing local authorities to issue bonds. Still, the pressure to repay and the leverage debt ratio make local them continue repaying debts by “borrowing new to repay old,” resulting in the accumulation of explicit and hidden debts.

According to the research data by Kaiyuan Securities, in 2020, the ratio of urban investment bond fund-raising indicated for “borrowing to repay the old” is as high as 85%.

Prospects of local debt to be managed

In January, Chinese state-media Xinhuanet said that the issuance of local bonds would be opened and implemented early. Special bonds of $230 billion were expected to be issued in the first quarter before the quota.

According to The Economic Reference News, Tang Linmin, a researcher at China International Futures Corporation, said that many local authorities in China had released local bond issuance plans for 2022. It is estimated that the volume of local bond issuance in the first quarter can reach about $260 billion. This number is close to the 2020 level.

Professor Zhang, a Chinese economist, said that China is now short of money in all aspects. The economic situation is not good, the international condition is not good, the cost is still high, and the issuance of bonds can only alleviate it.

Xia Yifan, a Japanese commentator, stated that the credit guarantor of local government bonds is themselves. The provincial authority doesn’t know what they will do with the money, what goals they will achieve, what their expected benefits will be, how they will be repaid, and so on, leading to mistrust and non-participation by the Chinese people. Even if there are some figures, how can they be implemented and verified? Therefore, local debt is a means to relieve the difficulties of local authorities, not a starting agent for the economy. The result now is a pile of bad debts and nothing else.

As hidden local authority debts and their solutions have become major concerns, the Shanghai University of Finance and Economics Institute of Advanced Research, in its October 2021 report, pointed out that “At present, many local authorities can only continue to roll over their debts by borrowing the new to repay the old, but this is just drinking poison to quench their thirst, it’s not a long-term solution.”

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