SinoInsight 1
On Dec. 22, mainland media outlet The Economic Observer reported the default of a city investment bond issued by the local government in Zhaoling District in Henan’s Luohe City. The bond was issued by another city investment platform in Zhaoling and was guaranteed (accounts receivable of not less than 600 million yuan) by Zhaoling District’s finance bureau. The bond issue size did not exceed 300 million yuan since it was issued in July 2017 and will mature in 24 months; at present, 72 percent of the bond’s principal has been repaid.
On Dec. 23, 112 investors held a press conference in Shanghai to discuss the default of bonds issued by Qinghai Investment Group, a local government financing vehicle (LGFV). The 500 million yuan bond was issued in May 2017 and issued in 24 installments. The bond’s first installment has been overdue for more than seven months.
OUR TAKE
1. The recent wave of LGFV and local government bond defaults or delayed repayments and installments are debunking the myth of “sure-pay” (剛兌) government investment bonds. As defaults continue to rise, the CCP authorities will find it difficult to sustain its Ponzi-like financial system and “control” systemic risks.
We warned in our China 2019 outlook that “the central government may order more infrastructure projects, but will find it tough selling bonds to fund the projects” and “local debt defaults will increase.”
2. 2019 saw a historic peak in the issuance of local government city investment bonds. According to mainland media reports, local city government financing platforms issued 2,349 city investment bonds valued at as much as 2.3 trillion yuan in 2016. And as of Dec. 11, 2019, local city government financing platforms issued 3,593 bonds valued in excess of 3 trillion yuan. Currently, the total value of city investment bonds has reached at least 8 trillion yuan.
2019 was also the year where most of bonds issued in 2016 and 2017 are due for repayment. According to publicly available data, local government city investment bonds and local debt repayments totaled 1.2 trillion yuan and 1.18 trillion yuan respectively in 2019; the figure will be 2.85 trillion yuan and 2.82 trillion yuan respectively in 2020.
As of Dec. 11, 2019, at least six LGFVs made revenue of fewer than 1 million yuan in the first half of the year; 43 LGFVs less than 10 million yuan; and 65 LGFVs less than 20 million yuan. However, the aforementioned LGFVs issued bonds in excess of 100 million yuan, and will face repayment issues. Faced with massive debts, LGFVs have found it hard to make ends meet as China’s economy deteriorates.
According to data from China’s finance ministry, the PRC’s national general public budget revenue was 17.967 trillion yuan from January to November 2019, an increase of 3.8 percent year-on-year. Meanwhile, the national general public budget expenditure was 20.6463 trillion yuan, an increase of 7.7 percent from a year ago. Also, China’s fiscal deficit reached 2.746 trillion yuan in the January-November period; China’s CPI in November was 4.5 percent, exceeding the rate of budget revenue growth.
On Dec. 19, Ma Jun, an external adviser to the People’s Bank of China monetary policy committee, told mainland media Securities Times that the default of some LGFV bonds could cause a “chain reaction” affecting tens of thousands of LGFVs in China, which would in turn damage investor confidence in the Chinese bond market.
We believe that China’s debt crisis will only grow more severe in the coming year and local governments will find it harder to issue bonds. Also, once debt defaults hit a critical threshold, it could spark a chain reaction and trigger systemic risks in the Chinese financial sector and economy.
SinoInsight 2
On Dec. 17, the PRC State Council held an inter-ministerial teleconference on the topic of “reducing enterprise burden.” During the teleconference, Xin Guobin, the deputy minister of industry and information technology, said that government departments and large state-owned enterprises have fully settled more than 580 billion yuan worth of accounts with private enterprises as of the end of November 2019. He added that the central government had settled 91 percent of debts with private enterprises, while local governments had cleared 61 percent. Xin also said that with the exception of individual provinces, local governments had met the target laid out in the 2019 government work report of settling more than half of debts owed to private enterprises.
On Dec. 22, the State Council issued an “opinion” on “creating a better development environment to support the reform and development of private enterprises.” According to the document, private economy in China plays an “important part” in advancing the development of the “multi-ownership economy with public ownership at the core,” and hence the PRC government must foster a better environment for private enterprises.
Main points in the “opinion” include:
- Further liberalization of market access for private enterprises to enter key industries and fields like energy, telecommunications, railways, oil, and gas;
- Further reduction of the tax burden for private enterprises, reduction of financing costs, and the cleaning up of account arrears;
- Strengthening of criminal protections for private enterprises and the safeguarding of legal property owned by private enterprises and entrepreneurs;
- Private enterprise reform and innovation will be encouraged;
- Party organizations will be established in private enterprises.
OUR TAKE
1. The PRC is attempting a propaganda spin with its latest policy moves concerning private enterprises to cover up for its poor treatment of the private sector in recent years.
Private enterprises have suffered greatly under the CCP’s bad policies. In 2013, the Xi Jinping government sought to “simplify procedures” (decentralize powers, enhance supervision, optimize public services) to benefit the private sector. Under the pressure of economic deterioration, however, the Xi government switched to the policy of “the state advances, the private sector retreats” (國進民退) in 2015. The policy change saw the implementation of so-called “supply-side reform” and the “monetization” of shantytown redevelopment projects, initiatives that transferred financial and debt risks from the SOEs to the private sector and the average Chinese. “The state advances, the private sector retreats” policy was further hammered home in 2018 with the publication of articles about the “elimination of private property” in the CCP’s Qiushi journal. The rapid worsening of the Chinese economy as a result of the Sino-U.S. trade war, however, appears to have forced the recent “reversal” in the CCP’s official rhetoric on the private sector.
2. The State Council’s latest policies suggest that its decrees to help private enterprises are either being ignored or being met with countermeasures. For instance, local governments only cleared 61 percent of the debts it owed to private enterprises in 2019. Based on conservative calculations, local governments and SOEs owe a total of nearly 1 trillion yuan to private enterprises, and those enterprises have to shoulder an additional financial burden of more than 50 billion yuan annually.
3. Facing financial difficulties, local governments and SOEs depend on being in arrears with private enterprises to maintain operations.
According to mainland media reports, the local government in Guizhou, an impoverished county with annual fiscal revenue of fewer than 1 billion yuan, recently spent 2.2 billion yuan building a copy of the Forbidden City. Recently, the secretary of the county committee responsible for the “Forbidden City” project was charged with taking bribes and related investigations found that the county’s liabilities amounted to over 40 billion yuan, or more than 40 times the county’s annual fiscal revenue. Construction companies in China usually require the making of advance payments; it can only be imagined what the Guizhou government owes private enterprises in arrears.
4. Per the PRC State Council’s latest “opinion” on private enterprises, the CCP plans to strengthen “criminal protections” for private enterprises. In other words, this means that China’s business environment is sorely lacking judicial fairness and the “rule of law”; more often than not private sector bosses face judicial injustice and many get arrested for petty offenses.
By “criminal protections,” we believe that the CCP actually plans to arrest and charge fewer people in the private sector (this will be arbitrary, and not in accordance with law).
5. It should be noted that the State Council’s “opinion” on improving the development of private enterprises demands that private enterprises establish internal Party organizations—an ironic gesture because tightening Party control over society is a big reason why private enterprises are doing less well to begin with.
We believe that increased Party control over private enterprises will be counterproductive and could lead to greater shrinkage of the private sector. This in turn would lead to the further worsening of China’s financial situation.
