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China Local Governments: The Slow Road To Stabilization


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China Local Governments: The Slow Road To Stabilization

What's Changed

China's economic transformation is pulling LRGs in opposite directions. Protracted property weakness, looming deflation risk, and sustained tax relief weigh on the sector's revenue generation into 2024. But steady industrial upgrading and a gradual consumption revival are also anchoring revenue growth.

S&P Global Ratings believes China's LRGs are poised for another difficult year. After 2024, however, we assume the sector will slowly get their finances in order, with a mild recovery in 2025 putting governments on a gradual path to fiscal health in three to five years.

We expect LRGs' revenue from land sales could drop by another 10% or more in 2024, before stabilizing. However, LRGs' expenses for preparing land for sale (land consolidation, the clearing of old homes, etc.) will also decline. Industrial land sales should perform relatively better, as China's ongoing industrial investment will support demand for such land.

The unused LRG bond quota could limit the room for further issuance of special refinancing bonds (SRBs). Governments can use SRBs to swap maturing hidden debt, and address other payment commitments.

We do not believe the SRB program is meant to deleverage local government financial vehicles (LGFVs). Moreover, after issuing about Chinese renminbi (RMB) 1.4 trillion of SRBs, LRGs' unused bond issuance quota dropped by half in 2023.

LRGs collectively held RMB1.4 trillion of such quota at the end of 2023. While clearly that is a big number, just as clearly it is not enough to settle the vast debts held by the LGFVs.

What's Next

The trajectory of LRGs' fiscal recovery remains unchanged. We assume the finances of local governments will stabilize as the Chinese property sector eventually bottoms, and governments stay disciplined on spending. That said, immediate revenue pressures and continued spending intensity could delay China LRGs' fiscal consolidation by another year.

We expect ongoing structural shifts to reshape spending priorities in the China LRG sector. Developed regions will likely continue to undertake fiscally expansive measures to support economic growth. The "Three Major Projects" initiative will also focus on China's largest cities, where underlying supply-demand fundamentals for basic housing and infrastructure are generally stronger.

The Three Major Projects is aimed at tackling housing problems in large cities, and could involve up to RMB3 trillion-RMB4 trillion in policy-driven land and property development over 2024-2025 (see "China LGFVs' Bigger Housing Role: Risk Control Matters," March 27, 2024.

However, more indebted regions will experience greater constraints around financing for new projects, in our opinion. Such regions will come under increased pressure to deleverage.

The debt levels of Chinese LRGs will likely keep rising in 2024. LRGs' new borrowing quota remains sufficient to fund public investment, as China remains cautious about exiting fiscal expansionary measures too abruptly. However, we expect LRGs to book revenue gains beyond 2024. This will help stabilize debt pressures.

The deleveraging effort will gradually force Chinese LRGs to distance themselves from SOEs, raising governments' selectivity in providing support for distressed entities. The growing commercialization of policy SOEs should also help LRGs mitigate long-term debt risk.

Key Risks

Material spending increases could derail LRGs' deleveraging effort. If China's property sector deteriorates beyond our current expectation, and LRGs ramp up spending to support initiatives such as the Three Major Projects, this would result in larger deficits. Already high debt burdens would swell even higher.

Likewise, should LRGs be pulled in to pay for an aggressive deleveraging of the LGFV sector, that could cause another spike in on-budget debt for LRGs. In an unlikely scenario, this could include the recognition by Chinese LRGs of large volumes of SOE commercial debt as hidden debt, possibly prompting governments to breach unused bond quotas to swap out LGFV debt.

Lengthy delays in LRGs' revenue recovery would also hamper fiscal stabilization. If China continues to roll out aggressive tax relief programs to support economic development, or continued property woes further squeeze fiscal resources, LRGs' debt control effort could be compromised. More tail risk would come to light.

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Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Yunbang Xu, Hong Kong (852) 9860-4469;
Secondary Contacts:Christopher Yip, Hong Kong + 852 2533 3593;
Wenyin Huang, Singapore +65 6216 1052;

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