China’s growth hopes rest on struggling local government financing vehicles
If the Chinese government is able to meet its economic growth target of 5.5% this year, it will be partly thanks to retail investors like Jane Song.
In May, Song invested 200,000 Rmb ($29,600) in a fixed-income wealth management product issued by a local government financing vehicle in the eastern province of Shandong. A financial adviser in Shanghai, she hasn’t been deterred by the growing reluctance of big investors to back LGFVs, which play a vital role in financing infrastructure development across China.
“If the WMP defaults, the local government will find it difficult to access credit in the future,” said Song, who expects to earn 8.8% interest on the “medium risk” product. “They won’t let that happen.”
The scale of the challenge China faces in meeting its annual growth target was underscored on Friday by data showing the economy grew just 0.4% year-on-year in the three months to June.
Achieving 5.5% growth for the year will only be possible if the LGFVs accelerate construction activity. But local government vehicles are struggling to borrow from banks and institutional bond investors, and are increasingly forced to offer retail investors high interest rates to raise funds.
Tapping retail investors directly, some for as little as Rmb 50,000 each, is a fresh start for LGFVs. They have traditionally raised capital from institutions – mainly banks – or wealthy individual investors acting through third parties such as trust companies and brokerage houses and with minimum investments set at Rmb 1 million.
But Beijing’s crackdown on shadow banking in recent years has made it more difficult to access these individual investments. The outstanding value of infrastructure-backed trust products fell by nearly half from the 2017 peak of Rmb 3.2 billion.
Last month, Limin Construction Development Group, an LGFV in the city of Zoucheng in Shandong, turned to social media platforms such as WeChat in its effort to raise Rmb 200 million from retail investors.
He promises an interest rate of 8.6%, much more than he would pay if the banks agreed to lend. The average annual interest rate charged by Chinese banks on business loans was 4.16% in June.
Limin’s prospectus does not specify how the proceeds will be spent, other than to say that it will help “replenish working capital.”
“You don’t need to know exactly how we’re going to spend the money,” said a Limin executive. “We’ll pay you back on time and that’s all that matters.”
The executive, who asked not to be identified as he was not authorized to speak to foreign media, added that the vehicle was close to reaching its fundraising goal.
Similar calls have been made on social media by hundreds of LGFVs across the country, raising fears that local governments that are already heavily indebted are racking up potentially explosive debt.
“It’s another way to [local governments] to delay the inevitable,” said Andrew Collier, managing director of Orient Capital Research in Hong Kong. “It’s the last gasp of a desperate economy trying to disguise its growth.”
Samuel Kwok, Asia-Pacific head of public finance at Fitch Ratings, said the issuance of short-term, high-cost debt by many LGFVs in economically weaker parts of China was a sign they had refinancing issues.
“Refinancing capacity is critical for LGFVs as they are expected to finance local economic development on behalf of governments,” Kwok said.
Bond investors and other more traditional creditors have grown more wary of LGFVs, even as Beijing makes them a policy priority to support infrastructure projects and boost an economy hit hard by the “zero-Covid” lockdowns of the President Xi Jinping.
LGFVs with a credit rating of AA or below raised only Rmb 204 billion net in the bond market in the first half of this year, down 50% from the same period in 2021, according to East Money Information. , a provider of financial data.
Several local banks, which across China are the biggest buyers of bonds, told the Financial Times that they avoid low-rated LGFV bonds. “We won’t go for LGFV bonds rated below AA+,” said an investment manager at a lender in the eastern city of Suzhou. “And there is a clear preference for bonds issued by economically strong regions.”
Limin, the Zoucheng-based LGFV, brought in 2.9 billion yuan in cash at the end of last year, of which nearly 80% could not access it because it had been pledged as a security deposit for the bank creditors.
“If you have 2.9 billion Rmb in cash and you rush to pay 9% for 200 million Rmb in private loans, this is pretending that you are creditworthy when you are not”, said Collier of Orient Capital.
Limin said he was “working normally”.
Yang Xiaoyi, a public finance analyst at Beijing consultancy Mingshu Data Technology, said it was increasingly common for LGFVs to delay repaying the principal they owe to investors while paying the annual interest due, essentially transforming their investments into perpetual bonds.
“You have to allow the investment to roll over indefinitely to avoid a default,” Yang said.
Regional authorities are aware of the risks. In an internal circular issued last month by the Henan provincial finance bureau and seen by the FT, the regulator said it would ban local LGFVs from selling debt securities directly to individuals. The ban came after hundreds of investors invested in multiple platforms offering annual returns of 8.5-10%.
“This practice,” the office said, “has seriously disrupted the economic and financial order and could easily lead to social instability.”