CHINA’S latest measures to deal with the financial risks of local officials have centred on a massive debt-swap plan, but a companion step is now drawing attention as a possible new tool.
Ever since China unleashed a massive wave of credit to stoke its domestic economy in the depths of the global financial crisis, policymakers have been dealing with the dangers posed by a structure on which that wave relied – the so-called local government financing vehicles (LGFVs). Now, economists see the potential for “central government financing vehicles” (CGFVs) to displace some of that activity, with greater oversight by national authorities.
China has given a green light for a total 500 billion yuan (S$93 billion) to be raised by two state-owned enterprises (SOEs) for the purpose of “stabilising the economy and expanding investment”. That was the first time such debt had been authorised.
“The CGFVs are one part of the broader shift towards the central government taking on a greater fiscal role to support economic growth, while the local officials manage their debt loads,” said Christopher Beddor, deputy China research director at Gavekal Dragonomics in Hong Kong.
It’s a change that economists have viewed as a long time coming. LGFVs were effective in getting around legal limits on official borrowing, and channelling cash into infrastructure and property development at a scale that supported overall economic growth. But their lack of transparency and relatively low returns on investment meant they posed a danger to the overall financial system.
Fiscal supplement
Beijing has struggled for years to address the situation. The government in November unveiled a 10 trillion yuan initiative to support local governments swapping “hidden” debt – mainly from LGFVs – for on-the-books obligations. The move aims to defuse local government debt risks and free up funds for other priorities, but it falls far short of the 60 trillion yuan of hidden debt estimated by the International Monetary Fund.
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The two state firms being tapped as potential CGFVs are China Reform Holdings and China Chengtong Holdings Group. They could add to fiscal stimulus next year if official budget measures prove insufficient to keep growth on target, according to Beddor.
“Policymakers could use the central state-owned enterprises to borrow and spend more without requiring legislative approval,” he said.
Wenyu Zhou, an associate director at Fitch Bohua, said the two companies could serve as a form of the “unconventional counter-cyclical adjustments” top leaders pledged at a Politburo meeting earlier this month. The leadership vowed to take “more active fiscal policy” to bolster the economy at that confab.
The size of the quota is unprecedented for the two firms, and amounts to the equivalent of half of this year’s special sovereign bond allowance.
Chengtong, China Reform and State-owned Assets Supervision and Administration Commission (Sasac) did not respond to requests for comment.
With their backing from Beijing, Chengtong and China Reform enjoy lower financing costs than LGFVs. They sold the five-year special bonds at 2.14 per cent on Nov 27, 12 basis points lower than the yield on top-rated LGFV notes of the same tenor.
Their healthier balance sheets also mean they will have greater scope to borrow and invest than LGFVs, and their use of funding may be more efficient thanks to their market and industrial expertise. With their chiefs appointed by the central government, the firms are also easier for Beijing to control than the thousands of LGFVs at the provincial, city and county levels.
“This could be the beginning of coordinating central SOEs to add leverage to help economic growth,” Citic Securities analysts including Yang Fan wrote in a note earlier this month. The companies “are expected to gradually replace local governments to undertake macro-investment functions in future”, they said.
Chengtong and China Reform have said the bond proceeds will be invested in major national projects focused on technology or strategic emerging industries and in support for the government-led cash-for-clunkers programme.
Corporate history
Citic expects they will drive as much as one trillion yuan in total equipment upgrading investment and boost fixed asset investment growth by as much as two percentage points next year.
Chengtong set up in 1992 by merging state-owned logistics companies, and China Reform, established in 2010 with a mandate to facilitate the restructuring of state firms, are the only two “state capital management companies” among the nation’s 98 central SOEs under the Sasac.
That status created conditions for them to grow into seasoned financial investors running a vast network of funds, brokerages and asset management units. China Reform has earned more than 20 billion yuan in annual profit for three consecutive years, and Chengtong said it’s increased earnings by more than nine-fold over the past eight years.
It’s unclear whether more state firms will take on functions similar to Chengtong and China Reform. Zhaopeng Xing, a senior strategist at Australia & New Zealand Banking Group, argues that the two firms have a “special role” as policy platforms, making it unlikely for others to join them.
Even if more central SOEs join any programme to replace LGFVs, the underlying challenges remain – because they will likely be tasked with borrowing to fund public initiatives that may be hard to generate enough profit to cover the debt.
“The worst-case scenario might be basically similar to the LGFV debt swaps happening now,” Beddor said. “It’s a downside risk.” BLOOMBERG
