This report does not constitute a rating action.
Key Takeaways
- The move by a district-level LGFV in Guizhou province to raise debt to address the liquidity issues of another LGFV serves as a temporary solution, at best.
- We believe this model will be hard to replicate broadly, and that it only will serve as a partial and temporary solution for emergency liquidity aid for some distressed LGFVs.
- While it is not a perfect fix for the LGFV's liquidity problems, it is perhaps the best fix given the constraints of time and resources now available.
What's an LGFV to do when it loses access to the bond market? One answer is to borrow credit standing from one or two peer entities. To put specifics to that concept, a district-level LGFV from Anshun city in Guizhou province will receive RMB1.8 billion through the sale of private bonds issued by a peer, with the deal guaranteed by a provincial-level SOE.
"We believe this model won't be broadly replicated," said S&P Global Ratings credit analyst Laura Li. "Even if it can be repeated, at best it will serve as a partial and temporary solution for emergency liquidity aid for some distressed LGFVs."
The particulars of the deal are that Guizhou Hongyingda Construction Project Management, a local government financing vehicles (LGFV), will issue private bonds, according to credible media reports. Anshun Xixiu Qiancheng Investment Development, a peer LGFV, will receive the funds. At the same time, Guizhou State Owned Asset Operation, a provincial state-owned enterprise (SOE), will guarantee repayment of the private bonds.
Notably, there is no equity relationship between Anshun Xixiu and Guizhou Hongyingda, though both are controlled by the same district government.
Swapping An Old Problem For A New One
The move is seemingly a part of a debt resolution measure coordinated by the Guizhou provincial government. However, it is essentially replacing an old problem with a new one, in our view. The deal could be a step backward for LGFV reform, and one that exacerbates moral hazard by adding yet another safety net when troubles arise for incautious borrowers.
If the policy is used by entities to expand borrowing, it could increase the total debt of China LGFVs. The arrangement may also introduce systemic risk, if strong LGFVs become overloaded with debt. The outcome could raise the credit risk of the LGFV sector, possibly testing the capacity of local governments to support failing entities more broadly.
"If the transaction is misused such that it expands debt issuance, it would be inconsistent with Beijing's policy of reducing local governments' reliance on debt-raising by its LGFVs," said S&P Global Ratings credit analyst Wenyin Huang. "As we often see, long-term national policy objectives may temporarily give way to fix a local problem."
According to media reports, this kind of dealmaking is temporarily permitted in 12 highly indebted regions, but only if it meets multiple conditions. The transaction as such will likely just serve as a temporary emergency measure for some distressed LGFVs.
For the arrangement to work, a local government needs to control a sufficiently creditworthy entity that can come to the aid of a weak one. Authorities identified the list of entities eligible for support in a confidential list circulated in March 2023. According to the criteria specified in policy directives, the issuance quota of the creditworthy entity is restricted to the sum of its own and the weak entity's bond maturities, among several other conditions, say press reports.
Guizhou Hongyingda was a good candidate to test this initiative. It is a new issuer--established in 2018--with limited debt and no outstanding bonds.
Temporary Relief, Not A Lasting Fix
The impact on local government credit standing is neutral, at this stage. We assume the total debt of key SOEs will stay unchanged, and the strong SOEs will have sufficient credit buffer to absorb the additional debt.
Guizhou is one of China's most indebted regions. We estimate the debt of Guizhou's district- and county-level LGFVs is above Chinese renminbi (RMB) 400 billion, or more than one-third of the province's total LGFV debt. Unsurprisingly, Guizhou LGFVs have seen their net bond financing shrink over the past several years.
To deal with its mounting local debt risk, the Guizhou government has issued RMB259 billion of special refinancing bonds. It is the largest provincial issuer of this type of security, which has been used by governments to raise capital to retire LGFV debt since late 2023. However, even this sizable amount was less than one-fifth of the province's total LGFV debt, by our estimate.
Anshun city itself had district- and county-level LGFV debt of RMB13 billion as of end-2022, with about three-quarters of this debt in the form of bonds. This makes it vulnerable to refinancing stress stemming from the ongoing capital market tightening.
Anshun was among the cities that we view as facing impending liquidity strain stemming from LGFV debt (see "China Policy Patches Alone Won't Fix LGFVs' Fraying Liquidity," published on RatingsDirect on Sept. 7, 2023). It is the smallest by GDP and fiscal revenue size among Guizhou's six cities and three autonomous prefectures.
Guizhou Is Active In Debt Resolution
In 2019 and 2020, Guizhou Moutai--a cash cow--twice transferred shares to Guizhou State Owned Asset Operation (which is also the guarantor of the private bonds to be issued by Guizhou Hongyingda).
Also in 2020, Moutai reportedly issued bonds to buy shares from Guizhou Highway, to alleviate debt pressure on Guizhou Highway. Debt resolution directives began even earlier than the broader push of the so-called "basket of measures" rolled out in July 2023, which were aimed at reining in LGFV debt risks.
In January 2023, Guizhou Zunyi Road and Bridge was the first to embark on a loan restructuring deal with banks, setting a precedent for peers.
We believe this new measure doesn't address LGFVs' main problem of finding better sources of repayment. However, it does demonstrate improving policy coordination where the central government, local governments, and financial institutions work together to ensure LGFV bond repayments. Progress of sorts, for now.
Editor: Jasper Moiseiwitsch
Related Research
- China LGFVs Face Higher Liquidity Risks As Funding Channels Tighten, Jan. 11, 2024
- Can China's 'Basket Of Measures' Defuse LGFV Debt Risks?, Nov. 21, 2023
- China's Fiscal Bid To Stanch Local SOE Debt Risk, Nov. 2, 2023
- Overaggressive Borrowing Is Backfiring For More Of China's LGFVs, Oct. 30, 2023
- China's District And County Recovery Crimped By Property Slide And Debt Checks, Sep. 13, 2023
- China Policy Patches Alone Won't Fix LGFVs' Fraying Liquidity, Sept. 7, 2023
- What Are China's Options To Resolve Local-Government SOE Debt Risk?, Aug. 2, 2023
- China's Local Governments Are Shedding Their Ties To Struggling SOEs, March 1, 2023
- China LRG in Focus--Guizhou Province, Jan. 11, 2023
| Primary Credit Analysts: | Laura C Li, CFA, Hong Kong + 852 2533 3583; laura.li@spglobal.com |
| Wenyin Huang, Singapore +65 6216 1052; Wenyin.Huang@spglobal.com | |
| Secondary Contacts: | Christopher Yip, Hong Kong + 852 2533 3593; christopher.yip@spglobal.com |
| Susan Chu, Hong Kong (852) 2912-3055; susan.chu@spglobal.com |
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