Beijing [China], December 5 : China is facing a looming financial crisis as it endeavours to address a colossal hidden debt problem within its banking system, The Wall Street Journal reported.
Cities and provinces across the nation have amassed a staggering amount of undisclosed debt through years of unchecked borrowing and spending, with estimates ranging from USD 7 trillion to USD 11 trillion in off-balance-sheet government debt, including corporate bonds issued by local government financing vehicles.
The extent of the issue remains uncertain, but it has become evident that local governments' debt levels are unsustainable amid slowing economic growth and deflationary pressures. Economists warn that a significant portion of the hidden debt, estimated between USD 400 billion and over USD 800 billion, is at high risk of default, as reported by The Wall Street Journal.
Chinese authorities recognise the severe risks to financial stability and overall growth, prompting a systematic approach to address the problem. They are initiating efforts to replace some hidden debt with new, explicit government debt, aiming to avert a wave of defaults that could lead to a nationwide financial crisis.
Yao Yu, founder of YY Rating, emphasises the potential consequences: "Once a local-government financing vehicle defaults, the situation can easily get out of hand." These financing vehicles represent a significant portion of China's domestic corporate bond market, and defaults could disrupt funding for other borrowers.
China's central government has expressed the importance of preventing and resolving the risk of hidden debts. In November, authorities warned that bankers and local government officials would be held accountable for life if they engaged in new hidden debt issuance. The People's Bank of China governor, Pan Gongsheng, pledged emergency liquidity support to regions burdened with high debt.
Moody's Investors Service recently lowered its outlook on China's credit rating to negative, citing increased support for financially stressed local governments and state-owned enterprises, along with risks to economic growth, according to The Wall Street Journal.
China has grappled with hidden debt risks for over a decade, with previous efforts between 2015 and 2018 attempting to address the issue. However, local governments, under pressure to stimulate growth, embarked on another borrowing spree. UBS reports that domestic banks' exposure to local government financing vehicles was around USD 6.9 trillion at the end of last year, representing about 13 per cent of the banking sector's total assets.
Financial strains are emerging as some cities and provinces face challenges due to a property downturn and extensive spending to combat the COVID-19 pandemic. Urgent measures include the issuance of special refinancing bonds to replace off-balance-sheet debt, with around USD 200 billion raised in such bonds by nearly 30 Chinese provinces and cities since October.
While these efforts aim to alleviate immediate liquidity problems, sceptics argue that they represent more of a refinancing plan than a restructuring plan. The potential long-term impact on China's economic growth is a concern, as fiscal resources may increasingly be allocated to debt repayment. A fundamental solution involves restructuring local government financing vehicles' debt to make them commercially viable entities, a challenging task in itself, The Wall Street Journal reported.
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