Financing platforms created by local governments in China should file for bankruptcy if they don’t have the funds to repay their debts, according to a guideline jointly issued by the Chinese Communist Party’s (CCP) general office and state council general office on Sep. 13.
These so-called local financing platforms refer to financial products offered in the form of land deals, equity shares, and government bonds—or local investment firms set up by municipal governments that focus on the construction and property development sector—that allow investment by ordinary citizens and private companies.
History of City Investment Companies
These firms became a popular option for local governments to borrow money from the public after the financial crisis in 2008. That year, the CCP launched the “4 trillion ($58o million) investment plan” to stimulate economic development, of which about 2.8 trillion yuan ($410 million) had to be raised by local governments. Around this time, city investment companies began popping up to attract investment, from just a few dozen in 2008 to more than 10,000 by 2010.
While loans from city investment companies, which are essentially funds borrowed from citizens and private firms, were regarded as high returns and low risk by banks, by 2013, the companies had accumulated billions of yuan (several hundred million dollars) of debt, much of which was about to mature.
However, many local governments were unable to repay even the interest, not to mention the capital. City investment companies were going to default on a large scale, even as mass defaulting by the firms would mean credit bankruptcy for the local governments.
Accumulating Debt Burden
Such debts accrued through borrowing money from investment companies aren’t officially recognized by the CCP.
According to the latest official data from China’s Ministry of Finance, as of the end of June 2018, all local governments’ debt totaled 16.8 trillion yuan ($2.45 trillion). But independent research shows that debts owed to city investment companies alone far surpass that number.
According to research by an industrial economics research institute at Nanjing University, 1,870 of China’s city investment companies had a total debt of 30 trillion yuan ($4.37 trillion) by the end of 2016. There are an estimated 11,000 city investment companies located in cities throughout China.
And according to estimates by a research team at Tsinghua University led by economist Bai Chong’en, as of the end of June 2017, the remaining debt of all city investment companies totaled 47 trillion yuan ($6.85 trillion).
Letting Them Default
At the end of 2014, in an effort to refinance local government debt, the CCP let local governments issue bonds to replace their debt. The CCP recognized 15.4 trillion ($2.25 trillion) of local government debt, which was to be converted into government bonds and become government debts within three years, beginning in 2015. In other words, the CCP didn’t recognize any of the debts owed to city investment companies and other entities.
The most recent guideline published by the CCP means city investment companies will be left to fend for themselves and go bankrupt. The decision was made to eliminate local governments’ enormous debts and reduce systemic financial risks, CCP state-owned media said.
But the guideline additionally stipulated the “active promotion of mixed-ownership reform,” revealing the true goal of the CCP.
By cutting off city investment entities from local government assistance and letting them default, the private firms that invested in those investment companies will lose their investments. When those firms can’t sustain themselves, they will be forced to undergo mixed ownership and merge with state-owned entities.
Economists also predict that when city investment companies go bankrupt, the domino effect on banks that loaned money to them, as well as the firms and households that invested in them, will be detrimental.