SINGAPORE (S&P Global Ratings) Oct. 16, 2024--China's plan to relieve local government "hidden debt" burdens could enhance transparency and free up capacity for stimulus spending. But S&P Global Ratings believes the first-order effect may just shift some government debt from one pocket to another. That means long-term debt risks could rise if the initiative fails to bolster growth.
"These measures mean China will see larger deficits and higher debt for the time being," said S&P Global Ratings credit analyst Rain Yin. "The impact on our sovereign rating on China depends on whether these elevated levels persist and turn into a structural component of China's fiscal situation."
China's Ministry of Finance (MOF) recently said it would "raise debt ceilings" to help swap out hidden debt--a form of off-budget borrowing through local government financing vehicles (LGFVs). We assume the scale of the relief could reach several trillion Chinese renminbi (RMB); this is larger than the swaps in recent years but doesn't match the RMB12 trillion seen in 2015-2018.
The MOF officials did not make clear whether the debt ceilings would be raised at the local or central level, but past swap programs came from local governments.
"If the Chinese central government issues the new debt, it would deliver the largest positive impact on local finances since local governments' debt burden will directly be reduced," said S&P Global Ratings credit analyst Wenyin Huang. "If local governments are tasked with the issuance instead, local finances may only see debt shifting from off-budget to on-budget without fundamentally lowering local governments' true debt burden."
In either case, we see positives from improved transparency of local government budgets, and better funding structure and interest costs.
But, Ms. Huang added, if local governments make the issuances, they could be saddled with higher deficits and faster debt accumulation if revenues fail to recover meaningfully. This is given the swaps will provide increased capacity to borrow for investments and initiatives under their regular debt issuance quotas.
IS THIS RELIEF ENOUGH?
The MOF has been trying to clean up local government finances since 2014. They have done this by allowing provincial-level governments to directly issue debt, whereas in the past local governments relied on their LGFVs to finance development spending. Healthier and more transparent local finances will in turn reduce systemic financial risk and provide better support to local economies.
However, local governments' hidden debt continued to accumulate. In 2018, a new round of hidden debt resolution began, spanning the next 10 years. With the revenue challenges, local governments are struggling to meet their approaching deadline to clear the hidden debts.
Policy directives and control since 2018 appear to be stricter on new hidden debts. Various reports of policies now circulating quote clear timelines for LGFVs' commercial transitions to become self-sustaining.
"The new policies look to draw a much clearer line between local government debt and local SOE debt," said Ms. Huang. "However, if more 'hidden debt' is discovered and recognized as local government debt down the road, downside risks to local governments' creditworthiness could be higher."
SOVEREIGN CREDIT IMPLICATIONS
If the central government does effectively underwrite these latest relief measures, the impact on the sovereign rating could still be limited. This is because our sovereign rating on China already encompasses the possibility of contingent liabilities from LGFVs crystallizing on government books.
"If these measures are insufficient to contain a wider fallout from deteriorating local finances, the government may need to roll out large fiscal stimulus measures year after year to support growth at a reasonable level," said Ms. Yin. "This would jeopardize the path to fiscal consolidation and debt levels stabilizing, resulting in a negative rating impact."
RELATED RESEARCH
- Chinese Local Governments Brief: The Search For Alternative Revenues Won't Be Easy, Oct. 9, 2024
- Research update: China Ratings Affirmed At 'A+/A-1'; Outlook Stable, June 27, 2024
- China Local Governments: The Slow Road To Stabilization, June 13, 2024
- China LRGs: Recouping Revenue Is Key To Fiscal Sustainability, March 27, 2024
- Credit FAQ: Policy Implications Of China's 2024 "Two Sessions", March 18, 2024
- SLIDES: China City Governments Risk Falling Into A Debt Trap, Feb. 20, 2024
- China Local Governments: Spending Choices Will Be Key To Fiscal Sustainability, Nov. 28, 2023
- China's District And County Recovery Crimped By Property Slide And Debt Checks, Sept. 13, 2023
This report does not constitute a rating action.
S&P Global Ratings, part of S&P Global Inc. (NYSE: SPGI), is the world's leading provider of independent credit risk research. We publish more than a million credit ratings on debt issued by sovereign, municipal, corporate and financial sector entities. With over 1,600 credit analysts in 27 countries, and more than 150 years' experience of assessing credit risk, we offer a unique combination of global coverage and local insight. Our research and opinions about relative credit risk provide market participants with information that helps to support the growth of transparent, liquid debt markets worldwide.
| Primary Credit Analysts: | Wenyin Huang, Singapore +65 6216 1052; Wenyin.Huang@spglobal.com |
| Rain Yin, Singapore + (65) 6239 6342; rain.yin@spglobal.com | |
| Secondary Contacts: | Christopher Yip, Hong Kong + 852 2533 3593; christopher.yip@spglobal.com |
| KimEng Tan, Singapore + 65 6239 6350; kimeng.tan@spglobal.com | |
| Media Contacts: | Ning Ma, Hong Kong (852) 2912-3029; ning.ma@spglobal.com |
| Michelle Lei, Beijing + 86 10 6569 2961; michelle.lei@spglobal.com |
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