Exclusive: China tells banks to roll over local government debts – sources

China Takes Steps to Reduce Debt Risks in Local Governments

China has instructed state-owned banks to restructure existing local government debt by converting them into longer-term loans with lower interest rates, as part of its efforts to mitigate debt risks in a struggling economy. The high levels of debt carried by municipalities in China pose a significant threat to the country’s financial stability, particularly during a period of deepening property crisis and the economic impacts of the COVID-19 pandemic.

Local government debt in China reached a staggering 92 trillion yuan ($12.58 trillion) in 2022, accounting for 76% of the country’s economic output, compared to 62.2% in 2019. A portion of this debt comprises loans from local government financing vehicles (LGFVs), utilized by cities to fund infrastructure projects, often at the behest of the central government to bolster economic growth. The depletion of local coffers could impede Beijing’s ability to stimulate a faltering economic recovery.

To address the issue, the People’s Bank of China (PBOC) recently issued directives to major state lenders, instructing them to extend loan terms, revise repayment plans, and reduce interest rates for outstanding LGFV loans. Loans that were originally due to be repaid by 2024 or earlier will now be classified as “normal” rather than non-performing if there are delays, and this will not negatively impact the performance evaluations of banks. This marks the first time that measures to defuse local debt risks have been reported for banks.

To ensure that banks do not bear substantial losses from the debt restructuring, the interest rates on the extended loans should not be lower than China’s Treasury bond rates. The loan terms are also not expected to exceed 10 years. At present, China’s 10-year government bond yields approximately 2.7%, while the benchmark one-year loan prime rate stands at 3.45%.

The purpose of these measures is to alleviate the rising concerns over local government debt. However, the central government in China has taken a cautious approach to resolving this issue to prevent moral hazard risks, where investors may assume that Beijing will always step in to aid local governments or state-owned enterprises, thereby encouraging greater risk-taking.

In addition to the debt situation, China’s property crisis has further exacerbated the difficulties faced by municipalities. With developers unable to purchase new plots of land, which traditionally served as a vital revenue source for local governments, pressure on their finances has increased significantly. Since mid-2021, around 40% of Chinese home sales have been made by companies that have defaulted, mostly consisting of private developers.

The People’s Bank of China (PBOC) and the National Financial Regulatory Administration have yet to provide comments in response to Reuters’ inquiries regarding these developments.

To address the major risks posed by local government debt, the Politburo, a top decision-making body of the Communist Party, announced in late July that a series of measures to reduce these risks would be unveiled. However, no detailed plans have been officially released to date.

The PBOC has stated that it will prioritize resolving debt risks in 12 regions that have been identified as high-risk, including Tianjin city, Guizhou province, and Guangxi province. The central bank will focus primarily on open market bonds and non-standard debt products that are due this year and next year.

Banks are being encouraged to issue new loans to LGFVs to facilitate the repayment of bonds and non-standard debt. Additionally, the PBOC plans to establish an emergency tool in collaboration with banks to provide loans to LGFVs during periods of short-term liquidity stress. LGFVs will be expected to repay these loans within two years.

In the 12 high-risk regions, some local governments may be required to pledge or transfer a portion of their stakes in local state-owned enterprises to banks in exchange for assistance in rolling over loans.

Last year, a government financing unit in the southwestern Guizhou province extended loans worth $2.3 billion by 20 years, with adjusted interest rates ranging from 3% to 4.5% per year.

The implementation of these measures highlights China’s commitment to addressing the challenges posed by local government debt and mitigating associated risks. By providing longer-term loans with lower interest rates, the hope is to alleviate the burden on municipalities and ensure the stability of the country’s financial system.

However, concerns remain about the overall debt situation in China and the impact it may have on the broader economy. Balancing the need for debt reduction with economic growth will be a delicate task for Chinese policymakers in the coming years.