China’s local government financing vehicles at lower risk of default in 2024: Fitch - South China Morning Post

China’s municipalities will see lower default risks at their local government financing vehicles (LGFVs) next year, thanks to a gradual recovery in fiscal revenues and policy support from the central government, analysts said.

LGFVs, which are platform companies set up by local governments to invest in infrastructure and social-welfare projects, will have more capacity to service their debt and fund public-sector projects in 2024 as local government revenues improve, said Sherry Zhao, senior director of international public finance at Fitch Ratings.

An improvement in government revenues will, in turn, be driven by an expected increase in operating income – consisting of items such as tax and fee incomes. This will more than offset a modest decline in capital revenues, which are mainly tied to land concessions, she added.

“Operating revenue has shown a moderate recovery of 8.8 per cent year on year for the first 10 months of 2023, albeit driven mainly by a value -added tax increase due to a low base from tax rebates implemented in 2022,” Zhao said. Transfers from the central government will also help mitigate local and regional governments’ revenue pressures.

However, a recovery in revenues and LGFV-funded projects is likely to vary across regions, Zhao said.

“Economically weaker regions may face a slower recovery and further tightening of infrastructure spending. Regions facing a deteriorating financing environment will also focus on refinancing instead of raising debt to fund new projects.”

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The liquidity pressures of LGFVs in economically weak regions are expected to be relieved somewhat through central government support, said Wang Lei, director of corporate ratings at S&P Global (China) Ratings. “However, LGFVs are still faced with substantial debt pressure, and this could pose systemic risks to banks.”

To ease investor concerns about LGFV defaults, municipalities across China have been issuing special refinancing bonds to service their debt. As of November, China’s local governments have announced plans to issue refinancing bonds totalling 1.3 trillion yuan (US$183.2 billion), or close to a quarter of the LGFV bonds that are due to mature by the end of 2024, according to S&P estimates.

Notably, highly indebted regions, such as Inner Mongolia, Yunnan and Guizhou, have been more active in issuing refinancing bonds compared to their more economically sound peers, such as Beijing, Shanghai and Guangdong, which are yet to announce plans to issue refinancing bonds.

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“While not all refinancing bonds can be used to swap LGFV bonds, these special bonds can provide capital support for highly indebted municipalities and help relieve their debt burden,” S&P’s Wang said. The effect of the refinancing bonds is already partially reflected in a recent increase in the number of local governments that are offering to pay off LGFV debt early, he added.

Different regions are also likely to see varying degrees of policy support from the central government, with the more economically sound and market-oriented municipalities expected to have better access to financing, while weaker regions will face more restrictions, according to Sun Hao, senior director of international public finance at Fitch.

“The task of the more heavily indebted regions is to reduce the scope of existing LGFV debt, rather than investing in new projects,” he said. “Their capital expenditure will mainly be funded by central transfers and special bond issuances.”

Meanwhile, LGFVs in the more economically developed regions are going through a period of transition, where public infrastructure investments are being gradually replaced by investments in industrial parks and real estate, which are “more effective in boosting local economic development”, Sun added.

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