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China’s funding vehicles reveal public finance risks

The impressive take-off in China’s economy over the last 15 years was made possible by huge infrastructure investment, largely debt-financed by LGs.

china's economyThe sustained rise of debt issued by Chinese local government financing vehicles (LGFVs), created to borrow off-balance sheet to meet China’s growth targets amid local government (LG) borrowing capacity restrictions, means it is important to account for related LGFV debt when analysing LG credit, says Fitch Ratings in a new report.

The impressive take-off in China’s economy over the last 15 years was made possible by huge infrastructure investment that was largely debt-financed by LGs. This led to total nominal credit expansion in 2015 being nearly 4x greater than nominal GDP expansion. China’s LGs now hold 71% of general government debt, a proportion that is higher than that of other major economies.

LGFVs’ debt stock continues to increase quickly. This is despite moves to allow more LGs to issue bonds – which opens up the prospect of China’s bond market becoming one of the world’s largest – and a major debt swap programme encouraging LGs to take back onto their balance sheets some debt initially issued by their LGFVs.

LGs do not guarantee their LGFVs’ debt, but in most cases it is clear the LGFVs’ debt service relies on financial support from the LGs. This dependency calls for prudent risk aggregation; Fitch usually rates the LGFVs based on the likelihood of support from the LG and believes most LGFV debt should be considered when evaluating the overall risk profile of a provincial or municipal group.

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