China’s real estate slowdown highlights another worrying debt problem
When officials in the southern city of Liuzhou started a routine land plot auction in June, they found few buyers.
Only one of the five plots was the subject of an offer; the rest remained unsold. As in many cities in China, a downturn in the real estate market has led to a drop in demand for the land on which high-rise apartment buildings are built.
This is bad news for local governments, which depend on sales for the bulk of their income. It is also a worrying sign for the holders of bonds issued by local authority financing vehicles (LGFV), these half-public, half-business concoctions that have become the cornerstone of Chinese development.
Income from city land sales is often used to repay these bonds. After the failed auction in Liuzhou, rating agencies downgraded two of the city’s LGFVs, fearing the government would struggle to repay debts.
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LGFVs are one of China’s strangest financial innovations. In the mid-1990s, the central government put in place budget laws to prevent local bureaucrats from taking on massive debt. In response, regional governments designed LGFVs as a workaround.
Vehicles, which number in the thousands, have become important engines of economic growth, helping to build bridges, homes and roads. They have also become one of China’s biggest liabilities, accumulating some 53 trillion yuan (NZ $ 12.35 billion, or 52 percent of GDP) in onshore and offshore debt, according to Goldman Sachs, a Bank.
Although these loans do not appear in the public balance sheets, the local authorities are responsible for repaying them. These rampant debts threaten to plunge the financial system into turmoil.
The central government has spent years trying to reform China’s shadow financial system, but debts hidden on balance sheets have been slow to emerge. Take shadow banking, for example. Although it has gradually declined as a proportion of banking system assets, the stock of phantom loans remains.
Many LGFVs earn meager income from the bridges, roads and water supply systems they build. Before, civil servants could make up the shortfall with income from the sale of land, but this is becoming more and more difficult.
In a series of sales this year for 22 of China’s largest cities, the premium collected on packages was only 4.7% above the government reserve price, down from 16.7% earlier within the year, estimates Enodo Economics, a research firm.
The default of Evergrande, a developer with $ 300 billion in liabilities, and widespread unrest in the real estate industry mean demand for land could continue to suffer.
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