Geographic Counterparty Risks

Traders and investors in China’s financial markets are starting to question the capacity of local governments to back implicit and explicit guarantees on bonds and corporate borrowing, including those from local government financing vehicles (LGFVs). Local debt risks are now interacting with local economic development: if banks and investors do not view a local government as creditworthy, the entire local economy can suffer, along with its banks, LGFVs, property developers, and state-owned enterprises. Many traders and lenders are now implicitly pricing geographic counterparty risk.

In this note, which updates our analysis of local debt from last December, we take a comprehensive look at financial data from 2,262 LGFV bond issuers, and break down the corresponding local debt burden by province and by city. Key findings include:

• Total LGFV debt has risen to at least 57.4 trillion yuan ($8.4 trillion) by June 2020. Local governments assume most of these implicit liabilities on top of 24.2 trillion yuan in official local debt, bringing total local debt to around 82% of GDP. But interest costs have come down, consistent with PBOC monetary easing.

• Default risks in the corporate bond market by province are highly correlated with provincial credit growth rates. Banks and traders are starting to restrict credit to risky localities.

• Infrastructure investment growth is slowing in highly indebted provinces even though these regions have issued more bonds, showing linkages between debt levels and the potential effectiveness of fiscal stimulus.

Beijing is trying to balance maintaining economic growth and reducing debt risks through its local government bond issuance, but in regions facing weaker fiscal conditions, these bonds will primarily be used to repay debt, not to fund new spending. Many more localities will face difficulties accessing new credit or investment as local debt risks rise, particularly in China’s northeastern and southwestern regions. Funding chains that have been critical to sustaining investment and policy credibility are starting to break down.


Posted September 9, 2020
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