Business Insider: "Hidden debts - a new threat to China's economy"

Andrei Iacomi
English Section / 29 august 2023

Business Insider: "Hidden debts - a new threat to China's economy"

The world's second-largest economy is already facing a number of problems, including deflation, record youth unemployment and a housing crisis, according to the US publication

The debts of China's local governments are estimated at ten trillion dollars, according to Insider

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For some time now, the markets have been influenced almost daily by the gloomy economic news coming out of China. The world's second-largest economy is grappling with a host of problems, including deflation, record youth unemployment and a deepening housing crisis, as the much-anticipated post-pandemic rebound has failed to materialize, according to Business Insider.

In fact, China's growing economic problems made American President Joe Biden call the Asian economy a "ticking time bomb", the mentioned source also writes. According to the American publication, now, a new no less dangerous economic threat tends to make its presence felt - the colossal problem of "hidden debts" of China. This mainly refers to a mountain of debt accumulated by the country's local authorities, mainly to finance regional infrastructure projects such as building roads and bridges.

According to an analysis by the Chinese publication Caixin Global, the payment obligations of the so-called local government financing vehicles (LGFVs) amount to almost ten trillion dollars. The Chinese government considers such debts as "off-the-book loans", which are not seen in the market, according to the mentioned source.

What are local authority funding vehicles?

Local government financing vehicles are bodies established by China to facilitate the financing of regional infrastructure projects. Originally created to support infrastructure projects such as highways, airports and energy facilities, LGFVs were designed to provide financing without subjecting themselves to official government constraints in Beijing, according to Business Insider.

The notion of "hidden debt" was defined by China's State Council in 2018 as any loan that is not reflected in the government's budget expenditures - essentially, "off-the-book financing," the source noted. After the 2008 global financial crisis, the LGFV sector grew exponentially as the Chinese government pushed to rapidly expand the country's infrastructure and public services to support China's remarkable economic growth, Bloomberg writes.

Estimates by Bloomberg and the International Monetary Fund put the total debt of China's LGFVs at more than $9 trillion - not far from Caixin's estimate. Local government bonds alone total about $2 trillion, and any default would hurt the Asian nation's $60 trillion financial system, according to Bloomberg. This year, the "hidden debt" of LGFVs rose above 50% of China's GDP for the first time, according to IMF data.

The importance of debt restructuring of local governments

For months, China's local governments have been struggling to turn these financing vehicles into profitable entities, putting pressure on the government in Beijing to support the sector with costly interventions. But as the problems and risks have piled up, banks have been unwilling to lend as much, investors have turned their backs on bonds, making viable projects harder to come by, according to sources close to the situation, Bloomberg writes .

Thus, China's local governments are having difficulty covering debt costs. "The most important variable impacting China's economic growth over the next two years will be the success or failure of local government debt restructuring," Logan Wright, head of China market research at Rhodium Group, told Bloomberg.

Echoes of the real estate crisis

While none of these LGFVs have yet defaulted, the problems in the sector overlap with the crisis in China's real estate industry, which began in 2021 with reverberations in global financial markets. "A possible collapse of local government investment would be comparable to the economic impact of the housing market crisis," Wright told Bloomberg.

The real estate sector accounts for about 30% of China's total output. But the high debt burden of the property industry and weak demand for new properties are among the factors that contributed to slowing the country's GDP growth in the second quarter, which came in at 6.3%, below forecasts of up to 7.1 %. Under these conditions, the aggravation of China's "hidden debt" problems would send shock waves through the global economy, according to Business Insider.