China’s Local Governments Want To Default On Their Debts?27 June, 2011, 18:45. Posted by Zarathustra
Tags: Debt, Economy, Local government
Just now, I talked about the huge discrepancy of the local government debts estimates between the National Audit Office and the People’s Bank of China. To recap, the People’s Bank of China thought there were some 14.4 trillion Yuan of debts, while the National Audit Office thought that there are only 10.72 trillion Yuan or so. Here, I followed the recommendation of Professor Victor Shih to add the non-LGFVs debts in the National Audit Office figure to the LGFVs number of the People’s Bank of China’s estimate and come up with the shocking 20 trillion Yuan estimate.
Which ever way is right, the risk does not appear to be immediate, except when it is. There are signs of local government financing vehicles attempting to default on their debts. Yunnan Highway Investment Limited, a local government financing vehicle (LGFV) specialising in investing highways, sent a letter to their bankers in April, declaring that “effective from today’s onwards, we will only be paying interest on our loans, and will stop paying principals” according to this report.
According to the report, this LGFV has borrowed close to 100 billion Yuan from China Construction Bank (939.HK), ICBC (1398.HK), China Development Bank and other banks. This LGFV was set up in 2006 and raised money from banks to investment in highways. According to plan, 4844 kilometres of highways will be completed by 30 June this year, which means, according to the debt covenant, this LGFV should be paying back the principal of the loans on top of interest payments.
Now, they don’t want to pay the principal because they don’t have the money. This is hardly surprising: over-investment is evident (see 10 Reasons to Short China), and the return on those investments are diminishing over years, thus these investments in infrastructure are not generating enough income to service its debt. According to a banker at China Development Bank, this particular LGFV is “not the worst” among highway investments companies in the Central-Western region of China.
For now, Yunnan government came to rescue, injected more capital to this LGFV and guarantee its debt, while demanded the LGFV to withdraw the letter. The immediate crisis seems to have been averted, but this tells a very chilling fact: many local governments are in financial stress. As one banker said, if the letter from Yunnan Highway Investment is not withdrawn, banks will have to made huge provisions, and this is not joking.