To get around borrowing caps, local governments in China are able to borrow heavily through state-owned investment companies known as Local Government Funding Vehicles (LGFVs).
The quasi-fiscal spending channelled through LGFVs has played a key role in infrastructure investment and growth promotion, but doesn’t appear on the balance sheet of local authorities despite the fact that, in some cases, it is implicitly guaranteed by them.
A boom in LGFVs borrowing in the aftermath of the financial crisis helped fuel a massive credit expansion in China – in 2015 it was nearly four times greater than GDP growth – prompting concern among observers.
In 2014, China issued a policy that it was thought would limit off-budget debt. It enabled local governments to issue municipal bonds, and established a debt swap programme to convert LGFV debt into them.
Around $2tn of LGFV debt was recognised by the government in 2015, with $3.2tn converted into bonds by the end of that year.
However, Fitch noted that LGFV debt has been resurging since. Reuters estimated in September 2016 that LGFVs debt had hit $106bn – already up 72% on 2015.
“Local governments do not guarantee their LGFVs’ debt, but in most cases it is clear the LGFVs’ debt service relies on financial support from local governments,” Fitch said. “This dependency calls for prudent risk aggregation.”
Another recent note by Fitch highlighted that public-private partnerships are likely to be the main financing model for Chinese local governments’ infrastructure investments in the years until 2020.
It noted however that state-owned enterprises (SOEs), rather than the private sector, are emerging as the main partner for local governments. While the private sector sniffs at the typical return on PPPs (5-8%), SOEs enjoy lower financing costs and so find them sufficient.
While Fitch said the longer lifecycles of PPP funding models could help “smooth out” local government budgets, it noted they would not help to reduce debt.
“Local governments’ contractual obligations to procure the service or subsidise projects are still considered public debt,” it stated.
