Rawhide in China

Rawhide in China

David Keohane

| Jan 02 11:30 | 3 comments | Share

China says rollover. From the FT’s Simon Rabinovitch:

Faced with a mountain of maturing loans this year, China has given local governments the go-ahead to issue bonds as a way of rolling over their debt to avoid defaults. The announcement by the National Development and Reform Commission, a top central planning authority, is the most explicit official endorsement of a massive debt refinancing operation that has become unavoidable and is already under way, analysts said.It comes on the heels of a report by China’s National Audit Office which said, and we paraphrase here, that China’s public debt load is manageable (30.3tn, or 56 per cent of GDP at the end June 2013, click here for a lovely table from UBS if you fancy more detail) even if the pace of its increase probably isn’t and if you don’t include corporate debt as the contingent liability it rather probably is. From Rabinovitch again:

Local government debt levels have soared 70 per cent to almost $3tn in less than three years, according to an official audit published on Monday. Nearly 40 per cent of that overall amount will mature before the end of this year, placing huge pressure on local governments to come up with the cash to make repayments.

With many of the original loans used for infrastructure projects that have yet to generate revenue, rollovers have long been seen as one of the few viable options for preventing defaults. Regulators have quietly allowed rollovers in the past while still discouraging them in public comments, fearful that cities and towns would exploit them as an easy way out of their debt troubles.

But the NDRC’s announcement makes clear that Beijing is now willing, on the record, to support rollovers for the so-called financing platforms owned by local governments.

“If construction projects face funding shortfalls and there is no way of completing the project to realise expected revenues, we will consider granting permission for these platform companies to issue an appropriate amount of new debt,” it said. “The funding that is raised can be used to ‘borrow new and repay old’ and for incomplete projects, ensuring that they will not end up half-finished.”

As the quote above suggests, rollovers aren’t new. It’s just that they’re now more explicit… and more expensive. As the FT noted, the yield on top-rated AAA corporate bonds has soared about 200 basis points to more than 6 per cent over the past half year. And while rollovers are fine if you can outgrow the problem, that hasn’t been true for a while even if you take, as the FT says, the more restrictive definitions of public debt favoured by the national audit office.

Stephen S. Roach over at Project Syndicate recently made the very reasonable point that China’s policy announcements, from the Third Plenum and the Central Economic Work Conference, don’t fit together all that well. Strategic meet tactical. Short term meet long. And it seems obvious that precisely that type of muddle is at work where debt is concerned. Whether the rollover announcement tells us much about how serious the government is about addressing the debt issue generally is debatable but we’d say… no. What happens next is more important. A final, very relevant chunk from UBS’s Wang Tao a few days ago (our emphasis):

Although the government seems determined to rein in local government debt, we think the progress will likely be slow as the government tries to balance a range of conflicting policy objectives. For example, on the one hand, the rapid accumulation of local debt has become a key risk to China’s macro stability, leading to the lining up of various measures to curtail this growth. On the other hand, however, the central government continues to place significant emphasis on GDP growth (with the 2014 growth target reportedly set again at 7.5%), with local governments still expected to play a leading role in expanding infrastructure, social housing and other urbanization and growth-related investment. If the later objectives are deemed more important, one cannot expect much progress towards reining in China’s local government debt in 2014, at least not in reality even if on the surface local debt is contained (much like how LGFV loans have slowed since 2010, but alongside accelerating use of other types of local government debt financing instruments).

How do we gauge on the seriousness of the government’s effort in containing local debt and what are the likely impacts on growth in 2014? Instead of an exhausting analysis through the many types of debt financing innovations which may spring up, two key indicators should be focused upon instead, and monitored closely to ascertain whether local government debt is being effectively contained. First, we should look at China’s overall credit expansion – in an economy where private sector demand is not super strong and profit margins have continued to face downward pressure, a rapid increase in overall credit levels may indicate the continued rapid accumulation of debt held by government-related entities. To monitor overall credit, we should look at the growth of total social financing (excluding equity) and beyond, as TSF fails to capture certain new credit activities (such as credit extended by securities companies). Second, we should monitor the pace of infrastructure investment, as that is largely carried out by local governments and financed by debt.

For 2014, we expect some but not significant progress in China’s efforts to restrict local government debt growth. As such, we expect growth in infrastructure investment to slow relative to 2013, but not sharply enough to outweigh the impact of improving export and consumption growth. Therefore, we maintain our 2014 GDP growth forecast of 7.8%. If the government is more serious about addressing local debt issue than we are envisaging now, then the introduction of measures to restrict local government debt financing for example, could bring downside risk to investment and our GDP growth forecast. On the upside, if the government continues to focus on the 7.5% growth target (which inevitably gets pushed up at each local level of implementation), then local governments will likely find more innovative ways to raise debt through the financial markets in support of investment.