In Depth: Local Governments Ditch Financing Vehicles to Offload Hidden Debt

China is conducting a campaign to reduce hidden borrowing by local government financing vehicles (LGFVs) to alleviate debt burdens. This initiative intends to turn heavily indebted local authorities' LGFVs into market-oriented entities, aiming to lower debt levels and ease central government borrowing restrictions [para. 1][para. 2]. However, analysts warn that this strategy might not resolve financial risks and could lead to new hidden debts. These market-oriented LGFVs may still invest in unprofitable infrastructure projects [para. 3].

In Chongqing, a municipality of 30 million people, four LGFVs were recently restructured to operate independently, holding the local government only partially responsible for liabilities. This approach has been adopted by 239 LGFVs in 24 provincial-level regions, and another tally highlights 454 LGFVs now operating as market entities or without government debt [para. 4][para. 5]. This change follows directives from the State Council to address local government hidden debt, an effort emphasized after a Politburo meeting in July [para. 9].

Local governments are struggling under heavy debt and finding difficulty balancing debt resolution with economic needs. LGFVs have historically funded infrastructure to meet GDP growth targets, resulting in substantial hidden debts. The International Monetary Fund estimates LGFV debt around 60 trillion yuan ($8.5 trillion) compared to 40.7 trillion yuan of official local government debt at the end of 2023 [para. 10]. The current debt resolution strategy involves issuing special refinancing bonds and directing banks to extend loan terms and lower interest rates [para. 11].

Local governments are seeking innovative ways to offload liabilities and access new financing, although this approach is still experimental and hasn't been officially approved by the central government [para. 12]. A national database was created to control hidden debt, restricting nearly 18,000 LGFVs from borrowing for anything other than "three major projects" [para. 13]. This step aims to prevent hidden debt buildup but cuts local economic development funding significantly [para. 14].

Chongqing's decision to separate some LGFVs from the local government’s balance sheet seeks to reduce debt-to-GDP ratio and lift project investment restrictions. The strategy involves a three-step approach: paying off hidden government debt, announcing the LGFV's independent status, and transferring liabilities to other companies. However, the third step, involving creditor negotiation, is particularly challenging [para. 17][para. 18]. Even with these steps, there's no guarantee the restructured LGFVs will secure new financing for local infrastructure projects [para. 19].

Being on the list of heavily indebted regions limits Chongqing's ability to invest in new projects, which significantly impacts local GDP growth alongside other struggles like the prolonged property market slump and weak consumer confidence. Over half of China's provincial-level regions missed GDP growth targets for 2023, adding to the pressure to meet new goals [para. 25]. To regain investment abilities, Chongqing aims to reduce its debt-to-GDP ratio by offloading some LGFVs. However, simply transforming LGFVs to market-oriented entities might not be enough to remove them from high-risk lists [para. 26][para. 27]. The main challenge remains in repaying LGFV debt, as restructuring doesn't eliminate liabilities or guarantee refinancing [para. 28].