China's long-awaited "hidden debt" swap strategy cuts funding costs for the RMB14 trillion burden. However, the new debt will go to the balance sheets of local and regional governments (LRGs), increasing their official debt. Risks may arise from debt redistribution between LRG tiers, or larger public investment programs than our current expectation.
Chart 1
What's Happening
LRGs now have clear guidelines on how to slash Chinese renminbi (RMB) 14.3 trillion in hidden debt to RMB2 trillion by 2028. They will issue special-purpose bonds (SPBs) to swap out the debt, and mobilize other resources. This is the first time that authorities officially disclosed the amount of hidden debt--off-budget borrowings issued via local government financing vehicles (LGFVs).
Why It Matters
Hidden debt may finally come to an end; the flipside is that official debt could rise by RMB10 trillion or 25% by 2028. RMB6 trillion in SPBs will come via a new quota, with the remaining RMB4 trillion carved out of the existing quota. This increase is not as drastic as it sounds because many institutions, including S&P Global Ratings, already factor in the debt of key state-owned enterprises into LRG debt assessments.
This latest swap could essentially resolve the vast majority of existing hidden debt, provided that local governments take heed of the central government's strict warnings against such practices. LRGs are not taking on other commercial debt from LGFVs.
We see downside risk to higher-tier LRGs' fiscal soundness. This could happen if systemically weak repayment ability at lower-tier LRGs breaks down the mechanisms preventing risks transferring upward. The announced measures move the hidden debt onto tier-one LRGs' balance sheets; however, the tier-one LRGs (i.e., provinces) may then onlend most of the swap bonds to tier-two and below (cities and districts). So the upper-tiers' fiscal health could be jeopardized if their lower counterparts struggle to repay.
LRGs typically have firm mechanisms in place to shield their fiscal positions from growing risks transferring from lower tiers. But in a downside scenario, larger repayment stress may require higher-tier governments to step in to a certain extent.
Accelerated debt accumulation is another downside risk. The swaps are meant to achieve several agendas at the same time (see "China's Latest Fix For Local Governments Could Turn Out To Be Debt Relief—Or More Burden," Oct. 15, 2024). However, if economic conditions cannot be stabilized then LRGs might receive a greater amount of debt quota than we anticipate, in order to increase project funding/economic activity.
What Comes Next
Our base case assumes SPBs for project funding will likely remain consistent with 2023-2024 levels over the next year. They may then gradually taper off from about RMB3.5 trillion (see chart 1). We keep our forecast even though the Ministry of Finance (MOF) signaled SPB programs could expand in 2025, given part of the quotas will be diverted to resolving hidden debt. We do not foresee a significant increase in SPBs for project funding, given the already-high debt burdens and limited fiscal space for LRGs.
Broadening SPB investment scope could also help lower the need to significantly increase debt quotas. In October this year, the MOF said that RMB2.3 trillion in SPBs for 2024 remains unallocated, indicating a higher scrutiny in approving investments and a scarcity of qualified projects. Funding utilization may improve if the investment scope were to broaden, including for the purpose of supporting the property sector and easing restrictions on using SPBs as registered capital in investment projects. This in turn could lower the need to significantly increase debt quotas.
Related Research
- Will China's Latest Stimulus Initiatives Achieve Lift-Off?, Oct. 25, 2024
- China Brief: LGFVs Face Credit Differentiation As Transition Deadline Looms, Oct. 17, 2024
- China's Latest Fix For Local Governments Could Turn Out To Be Debt Relief—Or More Burden, Oct. 15, 2024
- Chinese Local Governments Brief: The Search For Alternative Revenues Won't Be Easy, Oct. 9, 2024
- Is It Working? China's LGFV Debt De-Risk Program One Year On, July 25, 2024
This report does not constitute a rating action.
| Primary Credit Analyst: | Wenyin Huang, Singapore +65 6216 1052; Wenyin.Huang@spglobal.com |
| Secondary Contacts: | Christopher Yip, Hong Kong + 852 2533 3593; christopher.yip@spglobal.com |
| Felix Ejgel, London + 44 20 7176 6780; felix.ejgel@spglobal.com | |
| Rain Yin, Singapore + (65) 6239 6342; rain.yin@spglobal.com | |
| Research Assistant: | Chen Guo, Hong Kong |
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