China LGFV Debt Swap: Good and Bad News
Bottom Line: Reports suggest that China will swap Yuan1trn of local authority financing vehicle (LGFV) debt for local government debt to avoid problems in the weakest of the LGFV. This is good news in that it is more aggressive than recent incremental policy changes. However, it also bad news in that it shows that the LGFV debt problems are now bad enough that they could be an additional headwind for China’s economy – we have recently cut our 2024 GDP forecast to 4.0% on these debt worries (here). Focus now next week is whether the long awaited 25bps RRR cut or a 10bps medium-term facility (MTF) cut are delivered.
Figure 1: Local Government and Additional LGFV debt/GDP (%)
Source: IMF Article IV 2022 (here)
The details of the Yuan 1trn debt swap are still coming out, but news agencies suggest that it will be directed towards weakest LGFV’s in the troubled provinces including Guizhou, Hunan, Jilin, Anhui and Tianjin city (here). This is good news as it more aggressive action than recent targeted policy moves and appears to be a proactive attempt to avoid the weakest LFGV’s from failing. Local authorities will issue extra bonds, which are likely to be bought by banks and wealth managers with encouragement from China’s authorities. This round of debt swaps could also be followed by further rounds and it is worth remembering that the 2015 LGFV bailout was Yuan 12trn.
However, we would also regard it as bad news, as the authorities stepping in show that the weakest LGFV’s are running out of options. IMF estimates that these additional LGFVs, that are possible to recognise, had an estimate debt of Yuan 56.7trn or 47% of GDP in 2022 (Figure 1) and that this would rise to 66% of GDP by 2027. This debt is mainly loans, but includes an estimate Yuan13.5trn of bonds according to S&P Global ratings. Combined with local government debt, this would be a debt pile of 107% of GDP by 2027 (here). Now LGFV is not all the same, but the current bailout could cause the next weakest tier of LGFV’s to come under focus. It is likely that LGFV’s are also becoming more focused on survival, which will likely mean less support for the economy coming from this source.
The timing is also bad as the property developers crisis rolls on, with problems surrounding the huge Country Gardens. China authorities have previously undertaken a slow restructuring process for the weakest developers (e.g. Evergrande) to protect employees & subcontractors and to avoid any meaningful debt defaults. We could now see a period in H2 2023 and 2024 where debt restructuring is occurring for property developers and LGFV, which is one of the reasons we downgraded our 2024 GDP forecast down to 4.0% (here).
Focus next week is whether the long awaited 25bps RRR cut or a 10bps MTF cut are delivered. Both would be ideal, but the bias is that the 25bps RRR cut will arrive first, as it can help lending and mortgage growth more than an MTF cut.