China’s Debt Hangover
China’s debt problem is mainly a local one. This product, updated as of May 2021, contains both a “Debt Stress Indicator” (the first map) and a “Debt Drag Indicator” (the second map).
The stress indicator measures the extent to which each region is facing pressure to deleverage and ranks each region according to the stress score. The drag indicator ranks each region based on its existing debt’s drag on local GDP. You can also click on the rankings to see a more detailed breakdown of how each province stacks up nationally in terms of debt.
For detailed explanation of this product and its data, see the Overview.
Debt Stress Indicator
Debt Drag Indicator
More than a decade after the global financial crisis, China is still reeling from the debt hangover that was largely caused by the explosion of local government financing vehicles (LGFVs). The expansion of off-budget borrowing through the LGFVs was officially tolerated because it was meant as an emergency stop-gap effort to stimulate the economy after 2009.
That lending was more regulated as late as 2014, when Beijing still formally kept a tight lid on borrowing and mandated local governments to run balanced budgets. But Beijing soon realized that the LGFV genie couldn’t be put back into the bottle.
Indeed, the LGFV debt/GDP ratio has grown through 2020, up more than 30 percentage points since 2008. Debt growth is not necessarily a problem in and of itself, so long as the borrower maintains the ability to service that debt.
What is troubling is the fact that many LGFVs’ debt-financed investments can no longer service that debt, indicating that LGFVs have not invested wisely. In fact, returns on LGFV investment are on average below 2%, far lower than the cost of borrowing.
These lenders’ poor returns would have persisted as long as Beijing was willing to kick the can down the road. That’s because dealing with debt was always going to be a political decision since it touched the third rail of local government fiscal health.
But Beijing’s political calculus has changed. Having emerged from the pandemic, Beijing is doubling down on deleveraging, believing there exists a “window of opportunity” to tackle LGFV debt. We assume that in this political environment, regions and provinces must respond. In other words, it’s not a matter of whether, but how regions will deal their debt in coming years.
The central government’s newfound hawkishness on deleveraging will put tremendous stress on money-losing LGFVs that are essentially holding onto nonperforming assets. Given the scale of the LGFV debt challenge—totaling around $10 trillion—deleveraging will have major implications for regional growth.
How a region manages its deleveraging process will be one of the most important determinants of local economic performance. Fiscally strong regions will have the ability to control the pace of deleveraging, which will allow them to engineer an economic soft landing. In contrast, fiscally weak regions with plenty of money-losing LGFVs are going to have a rude awakening.
This is why we at MacroPolo sifted through 10 years of financial reports from more than 2,500 LGFVs and created both the Debt Stress Indicator and the Debt Drag Indicator. The first and new indicator aims to measure and rank the extent to which each region is facing LGFV deleveraging pressure. The second and updated indicator measures how much existing debt is dragging on the local economy.
What’s Different about This Product?
While other analyses of LGFV debt exist, we took a more refined approach to correct for bias and account for regional variation. We aim to present as realistic and accurate a picture of regional LGFV debt’s impact on the real economy as possible. Such province-by-province adjustments and extensive data imputations are important in ensuring the accuracy of the results and avoiding large errors due to bias in the data.
Our sample of 2,526 LGFVs accounts for 80% of total LGFV debt. To correct the problem of underrepresenting financially weaker LGFVs or those in economically weaker regions in our sample, we conducted substantial data imputation.
Some analyses simply assume that such under-representation of small and non-bond issuing LGFVs is evenly distributed across the country, when in fact strong evidence suggests that regional variation is substantial. For regions like Inner Mongolia or Liaoning, for example, bond-issuing LGFVs likely only account for less than 40% of total LGFV debt. In other municipalities like Beijing or Shanghai, bond-issuing LGFVs account for nearly all local LGFV debt. As a result, it is important to account for such variation and adjust regional LGFV debt accordingly.
For inquiries and suggestions, please contact Houze Song (firstname.lastname@example.org).
Medium government debt