News Analysis
At the close of 2020, China’s local government debt stood at $3.97 trillion. However, this does not include hidden debt, which is believed to be even larger.
The so-called “hidden debt” comes from entities that take loans, which are guaranteed by local governments. These loans do not appear on the balance sheets, but increase the indebtedness of the local government. A worrying trend, this debt has nearly tripled over the past 10 months. Economists at Goldman Sachs estimate that the hidden loans total around $8.2 trillion, roughly half of China’s GDP.
For years, the central authorities have pressured local governments to boost economic growth through infrastructure spending, much of which has been funded through local government financing vehicles (LGFVs). Now, both known and hidden debts have reached crisis levels and Beijing has suggested that it may allow some LGVFs to go into default.
In an effort to curb local government debt, a number of financial institutions are connecting their systems with the Ministry of Finance, which is monitoring LGFVs. Additionally, banks will no longer provide loans to entities whose credit is guaranteed by local governments. Beijing is also curbing bond sales by local governments.
In order to be more in-line with international standards, the central authorities have been talking about having greater transparency. However, in addition to the hidden debt of the local governments, China also has about $1 trillion in so-called shadow banking debts. These are off-balance sheet loans from non-banking institutions, which are harder to trace and quantify when calculating China’s total public debt.
Other murky practices that add to China’s overall indebtedness are wealth management products and high-yield investment vehicles, generally used to fund property development. The wealth management products themselves are sold as low-risk, but the actual investments inside are often high-risk, obscuring the danger of default—similar to what happened during the U.S. mortgage crisis. As a result, the People’s Bank of China and the China Banking and Insurance Regulatory Commission have restricted wealth management products from investing in bonds with a rating of less than AA.
A pedestrian walks past the People's Bank of China, China's central bank, in Beijing in this undated photo. Teh Eng Koon/AFP via Getty Images
To avoid a collapse of China’s property market, which could threaten the entire economy, the government imposed new restrictions—known as the “three red lines”—in August 2020. First, the debt to asset ratio of a property developer cannot exceed 70 percent. Second, the debt-to-equity ratio cannot exceed 100 percent. And finally, property companies must hold cash at least equal to their short-term liabilities. Unless a developer meets these three criteria, they cannot borrow from a bank.
These new regulations and restrictions contributed to the increased use of shadow banking and other opaque credit systems, which remained outside of government oversight. Local governments generate about one-third of their revenue through selling land to developers. Ultimately, the borrowing of property companies and local governments, through unregulated credit, caused China’s public debt to skyrocket.
