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COMMENTS

China Credit Spotlight: The Staying Power Of A US$3 Trillion Local Government Problem


China Credit Spotlight: The Staying Power Of A US$3 Trillion Local Government Problem

(Editor's Note: This article is part of our "China Credit Spotlight" series, which examines the credit conditions for China's top corporates and banks, key sectors, local and regional governments, and structured finance. )

China's push to end local governments' reliance on off-budget debt has so far been ineffective, with state-owned entities (SOEs) continuing to bury liabilities. S&P Global Ratings estimates this is a Chinese renminbi (RMB) 20 trillion (US$3 trillion) problem, with local government hidden debt equal to about one-quarter of Chinese GDP.

The issue presumably keeps policy planners and investors in cold sweats precisely because the debt is hidden. Few know which government-linked vehicle could blow up next, or to what extent the central government or state banks might need to bail out insolvent entities. The solution of central authorities has been to force local governments to drag their liabilities into view, and onto balance sheets. They also want local governments to solve their debt problems with their own resources.

But as local governments contend with rising deficits and indebtedness, those objectives have been eclipsed. Most will be unable to end their dependence on hidden debt over the next two to three years. We expect the level of such debt to stay stable, but that it will become a smaller part of total local government debt, which will increasingly be on balance sheet.

Much of this accounted for in our models. We maintain a stable outlook on the sector's creditworthiness, and we note that no SOE carrying hidden debt has defaulted yet.

Local Governments Still Need Their Funding Vehicles

There are no official data tracking China's off-budget-borrowing. We developed a range of proxy measures using data from WIND, a Chinese financial information company, alongside government and SOE figures.

We focused on the balance-sheet-management of the SOEs where the local government was the largest shareholder. This included financially weak SOEs that operate largely in form of local government financing vehicles (LGFVs) to fund social spending with little cash flow.

LGFV debt served as a proxy for hidden debt, on the view that such liabilities are not on the balance sheet but are ultimately backstopped by the local government.

We found that while the quantity of China's hidden debt problem is steady, the quality of the total debt composition is changing.

Chart 1

image

Chart 2

image

Authorities want local governments to stop hiding debt. But it also wants the governments to keep borrowing to fund projects that promote fixed-asset investment targets and GDP growth.

These objectives are often at odds with each other. Local governments would be stretched to borrow more while recognizing billions of dollars in fresh liabilities--investors might flee.

The workaround has been to let local governments continue to hide much of their legacy borrowing, but to force them to put new debt on their balance sheets.

We expect the new debt will focus on projects with cash flows. The hope is that the new debts will be largely self-funding and will not contribute to some fresh credit crisis down the line.

We expect local governments' on-budget borrowings will rise more than 10% over the next two years, supported by central authorities' willingness to let local governments fund capital expenditure (capex) with bond issuance. We project local governments' off-budget debt will rise at the mid-single-digit level only over this period.

Chinese local government debt, including off-budget borrowings, should grow in line with national GDP over the next two years.

Chart 3

image

Role Of Debt To Hitting Economic Targets

China's local governments need debt more than ever, to plug deficit holes, meet GDP targets, and fund infrastructure. The composition of local government debt is reshaping as these dynamics play out.

We've noted that the provinces with a high dependence on investment-linked growth have struggled to match national GDP targets over the past two years.

Recent controls on LGFV debt have led to a slowdown of new investment in China, especially for infrastructure, with local governments unable to fully take up the slack. If the economy slows down more than expected, we believe that central authorities will allow LGFVs to borrow more to help the country hit its economic growth targets.

Chart 4

image

While local government bond issuance and bond stock will stay high by global standards, we expect rapid changes in the use of such funds. In addition to refinancing (see, for example, the program to swap LGFV debt for local government debt initiated by central authorities in 2015-2018), new debt will be increasingly put to cash-flow-backed projects.

This debt--so-called special-purpose bonds--will be key to fund local government capex and an important catalyst to commercial projects driven by the private sector. We expect such issuance to surge, with the approval of the central government.

Debt-raising plugging holes in local government budgets

Since 2015 local governments' budget deficits have been widening. We expect this dynamic to persist for the next two years. This can be primarily attributed to tax cuts enacted to promote local growth.

The central government in 2018 cut corporate profit taxes (mainly to benefit small to midsized enterprises) and personal income tax (mainly to benefit the poor), which meant revenue growth for most local governments stayed modest. Increases in capex in 2018 and the first half of 2019 have added to local governments' deficits and debt piles. Capex spending should continue to rise over the next two years.

The central government's commitment to making large cash transfers to local governments was meant to mitigate these deficit challenges. However, the transfers have not kept pace with the wider economy or the commitments of local governments.

Chart 5

image

The upshot is that, as local governments wrangle their ever-enlarging deficits and spend to support the economy, central authorities have been less willing to press them on that other matter: putting huge blocks of hidden debt onto the balance sheet.

Top Tier Of Local Government Less Burdened By Hidden Debt

In our survey, we looked at top 14 provincial governments, which accounted for about 70% of China's GDP in 2018. We compare their tier-one performance with that of the "whole province" data, which captures the performance of all tiers of local government.

We found a widening gap between the fiscal performance of the top tier of local government and the rest.

China has a highly centralized political system, and a five-level administrative system comprised of the central government and four tiers of local government.

Provinces, autonomous regions, municipalities, and cities with state-planning status comprise China's first tier of local government, and have the strongest ties with the capital.

This tier has sufficient buffers to manage the most severe market or economic disruption. This can be mainly attributed to their better discretion, especially in capex.

Chart 6

image

China's tier two governments are mainly composed of cities of provinces, prefectures of autonomous regions, and districts of municipalities. These local governments generally operate in deficit because they have large capex responsibilities, but limited fiscal resources.

Lower tiers of local government are often dependent on their tier-one peers, receiving funds from their bond issuance.

Assuming widening deficits among local governments, we believe local governments' access to external funds will remain key to their public finances. In our view, the stronger local governments will be able to issue new bonds to fund important infrastructure projects, easing their funding strains.

We predict the top tier of local government will move out of hidden debt faster than lower-tier peers. The biggest, richest and more politically connected governments have enough funding to end the practice. But the poorer local governments are adding more hidden debt. This means that China's US$3 trillion problem is not going away.

Appendix

Table 1

Local Government Economic Profile
GDP per capita* GDP* Real GDP growth (%) Investment growth %
US$ RMB Bil. U$ Bil. RMB 2014 2015 2016 2017 2018 2014 2015 2016 2017 2018
Beijing 21,188 140,211 458 3,032 7.3 6.9 6.7 6.7 6.6 7.5 8.3 5.9 5.3 (5.5)
Chongqing 9,964 65,933 308 2,036 10.9 11.0 10.7 9.3 6.0 17.9 17.0 12.1 9.5 7.0
Fujian 13,781 91,197 541 3,580 9.9 9.0 8.4 8.1 8.3 19.0 17.4 9.3 13.9 11.5
Guangdong 13,058 86,412 1,470 9,728 7.8 8.0 7.5 7.5 6.8 15.9 15.9 10.0 13.5 10.7
Hebei 7,219 47,772 544 3,601 6.5 6.8 6.8 6.7 6.6 15.5 10.6 8.4 5.3 6.0
Henan 7,579 50,152 726 4,806 8.9 8.3 8.1 7.8 7.6 19.2 16.5 13.7 10.4 8.1
Hubei 10,067 66,616 595 3,937 9.7 8.9 8.1 7.8 7.8 19.3 16.2 13.1 11.0 11.0
Hunan 8,001 52,949 550 3,643 9.5 8.6 7.9 8.0 7.8 19.4 18.4 13.8 13.1 10.0
Jiangsu 17,404 115,168 1,399 9,260 8.7 8.5 7.8 7.2 6.7 15.5 10.5 7.5 7.5 5.5
Shandong 11,525 76,267 1,156 7,647 8.7 8.0 7.6 7.4 6.4 15.8 13.9 10.5 7.3 4.1
Shanghai 20,398 134,982 494 3,268 7.0 6.9 6.8 6.9 6.6 6.5 5.6 6.3 7.2 5.2
Sichuan 7,387 48,883 615 4,068 8.5 7.9 7.7 8.1 8.0 14.7 10.2 13.1 10.6 10.2
Tianjin 18,241 120,711 284 1,881 10.0 9.3 9.0 3.6 3.6 15.2 12.6 8.0 0.5 (5.6)
Zhejiang 14,907 98,643 849 5,620 7.6 8.0 7.5 7.8 7.1 16.6 13.2 10.9 8.6 7.1
China 9,769 64,644 13,605 90,031 7.3 6.9 6.7 6.8 6.6 15.7 10.0 8.1 7.2 5.9
*Calendar year 2018. RMB--renminbi. Bil.--billion. Source: National Bureau of Statistics, S&P Global Ratings.

Table 2a

Local Government Fiscal Profile
Whole province basis
Total revenue* Revenue composition (2018) (%) Balance after capital accounts as % of total revenue†
2018 (bil. RMB) General revenue Government funds Transfer payments§ 2014 2015 2016 2017 2018
Beijing 880 65.7 22.8 11.5 7.2 (10.6) (10.4) 1.5 (15.1)
Chongqing 645 35.1 35.9 29.0 (8.8) (5.3) (7.6) (3.3) (12.2)
Fujian 664 45.3 38.9 15.8 1.8 (9.4) (6.9) (10.1) (17.8)
Guangdong 1,979 61.2 29.8 9.1 3.1 (19.4) (7.8) (8.1) (8.3)
Hebei 956 36.7 30.3 32.9 1.9 (8.4) (9.6) (7.4) (15.6)
Henan 1,159 32.5 24.9 42.6 0.0 (4.6) (7.0) (7.8) (3.7)
Hubei 1,005 32.9 35.2 31.9 7.3 (0.8) (7.0) (11.3) (11.8)
Hunan 862 33.2 25.9 41.0 (1.4) (4.5) (6.4) (9.3) (12.0)
Jiangsu 1,867 46.2 44.0 9.7 0.4 (3.0) (3.5) (8.4) (12.0)
Shandong 1,541 42.1 38.9 19.0 (1.0) (6.2) (7.3) (8.8) (9.6)
Shanghai 1,007 70.6 20.8 8.6 4.4 (0.9) (4.0) (4.1) (8.8)
Sichuan 1,264 30.9 30.2 38.8 (2.3) (3.7) (8.2) (6.4) (8.9)
Tianjin 377 55.9 30.8 13.2 1.1 (2.8) (7.5) (13.1) (26.2)
Zhejiang 1,644 40.1 53.1 6.7 0.7 (12.4) (5.2) (6.2) (10.8)
China 23,996 40.8 29.8 29.4 0.1 (6.8) (7.0) (7.6) (11.4)
Top 14 LRGs‡ 15,850 45.2 34.4 20.3 1.2 (7.2) (6.8) (7.2) (11.1)
*Total revenue: Sum of operating revenue, capital revenue and transfer inflows. §Transfer payments: Both operating account and capital account. †Balance after capital accounts as of total revenue as per S&P Global Ratings criteria. ‡Local and regional governments--refers to top 10 tier-one governments as measured by GDP scale, and all four municipal governments. RMB--renminbi. Bil.--billion. Source: Local government fiscal reports, Ministry of Finance, S&P Global Ratings.

Table 2b

Local Government Fiscal Profile
Tier-one local government
Total revenue* Revenue composition (2018)(%) Balance after capital accounts as % of total revenue†
2018 (bil. RMB) General revenue Government funds Transfer payments§ 2014 2015 2016 2017 2018
Beijing 596.9 56.4 15.2 28.5 5.6 (8.0) (6.4) 3.7 (9.9)
Chongqing 415.4 20.7 29.1 50.2 (3.0) (4.9) (2.7) 1.6 (8.7)
Fujian 155.4 17.0 1.8 81.2 (12.0) (28.3) 0.7 3.7 1.5
Guangdong 544.6 57.5 1.2 41.4 (7.1) (16.2) 5.2 0.1 (0.8)
Hebei 418.0 17.9 5.6 76.5 (0.1) (3.3) (1.8) (0.8) (0.9)
Henan 534.0 3.9 5.1 91.0 0.2 (3.6) (1.9) (2.6) (1.4)
Hubei 411.9 3.5 3.7 92.8 2.3 (7.9) (0.3) (0.8) (2.8)
Hunan 431.6 11.9 3.7 84.4 (2.5) (6.2) (4.8) (4.1) (5.4)
Jiangsu 393.9 6.8 3.2 90.0 0.3 (1.3) 1.5 2.1 (5.9)
Shandong 365.2 6.5 2.0 91.6 (2.1) (7.3) (6.7) (4.9) (4.8)
Shanghai 503.5 66.8 12.2 21.1 7.8 3.0 (2.0) 4.8 (7.5)
Sichuan 597.7 13.2 1.0 85.7 (0.4) (1.2) (2.8) 0.8 0.3
Tianjin 186.4 46.4 24.3 29.3 (1.7) (7.3) (2.2) (13.1) (13.5)
Zhejiang 280.5 11.1 2.9 86.0 7.5 (17.0) (0.6) (5.2) (3.6)
China N.A. N.A. N.A. N.A. 0.0 (5.3) (2.5) (2.0) N.A.
Top 14 LRGs‡ 5,835.0 25.8 7.6 66.6 0.2 (6.3) (1.8) (0.3) (4.4)
*Total revenue: sum of operating revenue, capital revenue and transfer inflows. §Transfer payments: both operating account and capital account. †Balance after capital as of total revenue as per S&P Global Ratings criteria. ‡Local and regional governments--refers to top 10 tier-one governments as measured by GDP scale, and all four municipal governments. RMB--renminbi. Bil.--billion. N.A.--Not available. Source: Local government fiscal reports, Ministry of Finance, S&P Global Ratings.

Table 3

Local Government Official Debt Composition
Whole province basis Tier-one local government
Province Official government debt* (bil. RMB) 2018 official debt stock 2018 official debt stock
2014 2015 2016 2017 2018 Debt owed for projects with no cash flow§ Debt owed for cash-flow-backed projects Official debt to GDP (%) Official debt to adjusted operating revenue§ (%) Adjusted official debt† (bil. RMB) Debt owed for projects with no cash flow§ Debt owned for cash-flow-backed projects Adjusted official debt† to adjusted operating revenue§ (%)
Beijing 638 573 374 388 425 203 221 14.0 62.6 160 100 60 32.8
Chongqing 325 338 374 402 469 236 233 23.0 115.2 142 63 79 50.4
Fujian 416 422 449 490 542 260 282 15.1 134.0 10 9 1 6.9
Guangdong 849 819 840 891 996 529 467 10.2 71.8 105 90 15 19.5
Hebei 548 531 569 615 728 456 271 20.2 109.6 71 67 4 18.2
Henan 534 547 552 555 654 406 248 13.6 75.4 88 73 15 17.4
Hubei 444 457 510 572 668 374 293 17.0 103.4 34 - - 8.7
Hunan 627 615 683 767 871 558 313 23.9 137.1 170 143 27 41.4
Jiangsu 1,064 1,056 1,092 1,203 1,329 665 663 14.3 127.7 53 51 2 14.0
Shandong 821 814 849 913 1,144 637 506 15.0 122.2 92 66 26 26.0
Shanghai 581 488 449 469 503 264 239 15.4 63.3 71 36 35 16.2
Sichuan 749 747 781 850 930 547 383 22.9 106.6 59 59 - 10.1
Tianjin 250 238 291 342 408 140 268 21.7 156.7 153 42 111 108.8
Zhejiang 685 643 699 770 1,079 581 499 19.2 140.7 37 21 16 13.7
China 15,400 16,000 15,400 16,471 18,386 10,994 7,392 20.4 109.7 N.A. N.A. N.A. N.A.
Top 14 LRGs 8,531 8,288 8,512 9,227 10,745 5,857 4,888 16.5 122.4 1,246 821 390 23.4
*Debt explicitly under local-government legal name, including bonds and non-bonds. §Adjusted operating revenue: operating revenue plus operating transfer inflow. †Adjusted official debt: Local-government direct debt after deducting on-lent debt to lower tier governments. N.A.--Not available. RMB--renminbi. Bil.--billion. LRGs--Local and regional governments. Source: Local government fiscal reports, Ministry of Finance, S&P Global Ratings.

Table 4

Local Government SOE Debt Profile
Whole province basis Tier one local government
Total SOE debt* (bil. RMB) Total SOE debt % to GDP LGFV debt (bil. RMB)§ Total local-government debt and LGFV debt as % of consolidated revenues † Total SOE debt‡ (bil. RMB) Provincial SOE debt as % whole province total SOE debt LGFV debt§ (bil. RMB) Total local-government debt and LGFV debt as % of consolidated revenues † Total local-government debt (without on-lent debt) and LGFV debt as a % of consolidated revenues
Beijing 4,476 147.6 1000-1500 60-120 1,859 41.5 300-500 60-120 60-120
Chongqing 1,366 67.1 500-1000 120-240 461 33.8 300-500 120-240 60-120
Fujian 1,382 38.6 <500 60-120 413 29.9 100-300 >240 60-120
Guangdong 3,196 32.9 1000-1500 60-120 575 18.0 300-500 120-240 60-120
Hebei 1,146 31.8 <500 60-120 599 52.3 100-300 120-240 <60
Henan 1,400 29.1 500-1000 60-120 630 45.0 300-500 120-240 60-120
Hubei 1,746 44.4 1000-1500 120-240 384 22.0 300-500 120-240 60-120
Hunan 1,669 45.8 1000-1500 120-240 32 1.9 <100 120-240 <60
Jiangsu 5,591 60.4 >1500 >240 318 5.7 100-300 >240 <60
Shandong 3,053 39.9 500-1000 60-120 1,324 43.4 100-300 120-240 60-120
Shanghai 1,870 57.2 <500 60-120 644 34.4 100-300 60-120 <60
Sichuan 2,698 66.3 1000-1500 120-240 665 24.6 <100 120-240 <60
Tianjin 2,132 113.3 >1500 >240 819 38.4 >500 >240 >240
Zhejiang 3,146 56.0 >1500 120-240 320 10.2 100-300 120-240 <60
*Total SOE debt: debt of SOEs with oustanding onshore bonds. §Local government financing vehicles. Refers to SOE debt of SOEs that S&P Global Ratings deems as financially or operationally dependent on a local government †Consolidated operating revenues: Local government operating revenues, plus operating revenue generated by referenced SOEs. ‡Total SOE debt: debt of provincial-level SOEs with outstanding onshore bond. SOE--State-owned enterprise. Source: WIND, local government fiscal reports, Ministry of Finance, S&P Global Ratings.

Related Research

  • Institutional Framework Assessments For International Local And Regional Governments, July 4, 2019
  • Credit Conditions Asia-Pacific: Return Of Uncertainty, June 27, 2019
  • How Can China Cut Taxes And Maintain Low Budget Deficits?, March 11, 2019
  • Lifting The Lid On China's Local And Regional Government Debt Levels, Oct. 16, 2018
  • Chinese LRG Risk Indicators By Province, Oct. 16, 2018

This report does not constitute a rating action.

Primary Credit Analyst:Susan Chu, Hong Kong (852) 2912-3055;
susan.chu@spglobal.com
Secondary Contacts:Felix Ejgel, London (44) 20-7176-6780;
felix.ejgel@spglobal.com
KimEng Tan, Singapore (65) 6239-6350;
kimeng.tan@spglobal.com
Research Assistant:Sandy Ng, Hong Kong

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