New government program to help resolve provinces' hidden debts

China has started a special refinancing bond program to service the outstanding hidden debts of the governments of a number of provincial regions, which analysts said marked a key step forward after the central government proposed a package of debt relief measures.

Starting from September, more than 20 provinces participating in the program have issued or announced issuance plans with the aggregate amount about 1 trillion yuan ($136.6 billion), according to a report released last month by Fitch Ratings, a global credit ratings firm.

The amount is equivalent to around 30 percent of the total bond value of local government financing vehicles — funding mechanisms that lower-level governments use to borrow money for projects — that is expected to mature in the next 12 months, according to the report. For example, South China's Guangxi Zhuang autonomous region issued a total of 12.5 billion yuan worth of bonds on Oct 30, according to a statement issued by local financial authorities.

As debt remains a significant constraint on local government efforts to stabilize growth, finding effective solutions to the debt burden remains high on the central and local governments' work agendas, said Wen Bin, chief economist at China Minsheng Bank.

The primary purpose of the program is to swap the costly, short-term hidden debt — money owed by LGFVs that doesn't appear on balance sheets of local governments — with special refinancing bonds that have longer maturities and lower interest rates and keep them on balance sheets for greater regulatory transparency, Wen said.

The issuance of special refinancing bonds will allay the market's concerns about the debt risks of LGFVs, enhance their liquidity and help restore refinancing capacity, said Luo Zhiheng, chief economist at Yuekai Securities, whose research focuses on China's fiscal policies and conditions.

In the meanwhile, it will also aid in clearing arrears owed to business and guarding against financial and economic hazards brought on by businesses' inability to collect accounts receivable, Luo added.

It is challenging to solely rely on the issuance of special refinancing bonds to solve the issue fundamentally, as noted by a report released by CITIC Securities. Additionally, local government debt is unevenly distributed among China's regions, with some areas facing higher levels of debt risks and greater repayment pressures.

Furthermore, the central government has taken a cautious stance on this debt resolution approach in order to prevent moral hazards. If investors believe authorities will constantly step in to save local governments or State-owned businesses, they may be enticed to take even bigger risks, said Qiao Baoyun, dean of the China Academy of Public Finance and Public Policy at the Central University of Finance and Economics.

Financial institution-led loan restructuring and LGFV asset disposal could also stand as viable options, but they might only be used sparingly, Qiao added.

Official data showed that outstanding local government debt totaled 38.89 trillion yuan by the end of September, while the official budget cap for the whole year is 42.16 trillion yuan.

The figure does not consider hidden debts introduced by LGFVs, for which estimates vary from less than 40 trillion yuan to more than 50 trillion.

Analysts said that a coordinated rescue package involving a combination of additional funding or refinancing channels and payment extensions, debt swaps and possible debt restructurings will be rolled out in a timely manner. The Political Bureau of the Communist Party of China Central Committee reaffirmed during a meeting in late July that it will prioritize a range of actions to mitigate the risks associated with local government debt.

In mid-August, the People's Bank of China, along with the country's top financial regulator and the securities regulator, vowed efforts to coordinate support and initiate more policies to prevent and resolve debt risks, strengthen risk monitoring and firmly hold the line on avoiding systemic risk.

The purpose of defusing debt concerns is to avoid the emergence of systemic risk through debt restructuring, which is a goal that can be achieved rather than paying off all debts, said Li Xuhong, a professor at the Beijing National Accounting Institute.

The majority of the projects and assets backed by the nation's local government bonds are of good quality, and the continuous economic recovery increases the repayment capacity of LGFVs, so the risk associated with local government bond debt is controllable, Li added.