China Tells Banks to Restructure Local Government Debt
China’s Efforts to Reduce Debt Risks in Faltering Economy
China has instructed state-owned banks to restructure existing local government debt by providing longer-term loans at lower interest rates. This move is part of Beijing’s strategy to mitigate debt risks in a struggling economy. Economists warn that debt-laden municipalities pose a significant threat to the world’s second-largest economy and its financial stability. The ongoing property crisis, excessive investment in infrastructure, and mounting costs of managing the COVID-19 pandemic have exacerbated this risk.
Local Government Debt Reaches Alarming Levels
In 2022, local government debt in China reached a staggering 92 trillion yuan ($12.58 trillion), accounting for 76% of the country’s economic output. This is a significant increase from 2019 when it stood at 62.2% of the GDP. A substantial portion of this debt is issued by local government financing vehicles (LGFVs), which cities utilize to fund infrastructure projects, often under pressure from the central government to boost economic growth. However, the depletion of funds could hinder Beijing’s efforts to revive its faltering economy.
Measures Implemented by the People’s Bank of China (PBOC)
The People’s Bank of China (PBOC) has recently issued directives to major state-owned lenders, instructing them to extend loan terms, adjust repayment plans, and reduce interest rates for outstanding loans to LGFVs. Under these measures, loans originally due in 2024 or earlier will be classified as “normal” rather than non-performing loans if they become overdue. This will not negatively impact the banks’ performance evaluations. These are the first reported steps taken by banks to address local debt risks.
Guidelines for Restructuring Loans
To minimize potential losses resulting from debt restructuring, the interest rates on rolled-over loans should not be lower than China’s Treasury bond rates. Additionally, loan terms should not exceed 10 years. Currently, China’s benchmark 10-year government bond yields around 2.7%, while the benchmark one-year loan prime rate stands at 3.45%. These guidelines aim to strike a balance between mitigating risks and ensuring banks’ stability.
Cautionary Approach and Deepening Property Crisis
China’s central government has adopted a cautious stance on resolving local government debt issues to avoid creating moral hazards. It aims to prevent investors from assuming that Beijing will always come to the rescue of local governments or state-owned enterprises. The deepening property crisis has further exacerbated the financial pressure on municipalities, as developers are unable to purchase new plots of land. Since mid-2021, 40% of Chinese home sales have defaulted, primarily affecting private developers.
China’s Plans for Debt Risk Reduction
China’s Politburo, a top decision-making body of the Communist Party, announced in late July that it would introduce measures to reduce local government debt risks. However, detailed plans have not been officially unveiled yet. The central bank’s priority is to address the debt risks in 12 identified high-risk regions, including Tianjin city, Guizhou province, and Guangxi province. The focus will be on open market bonds and non-standard debt products due in the coming years. Banks are encouraged to issue new loans to LGFVs to repay bonds and non-standard debt.
Emergency Liquidity Tool and Stake Transfers
The PBOC plans to establish an emergency tool in collaboration with banks to provide short-term liquidity support to LGFVs facing financial stress. LGFVs will be required to repay these loans within two years. In high-risk regions, some local governments may need to pledge or transfer part of their stakes in local state-owned companies to banks in exchange for assistance with loan roll-overs.
Conclusion
China’s efforts to restructure local government debt are crucial to mitigate risks in its struggling economy. By providing longer-term loans at lower interest rates, the government aims to address the mounting debt burden while minimizing potential losses for banks. The deepening property crisis and cautious approach to resolving debt issues highlight the challenges China faces in stabilizing its economy. As the situation unfolds, it remains to be seen how effective these measures will be in reducing local debt risks and reviving economic growth.
