China to Clean Up Billions Worth of Local Debt

Beijing is to take on some 2-3 trillion yuan of local government debts according to Reuters, hoping to stave off a wave of destabilising defaults in the future.

As part of Beijing’s overhaul of the finances of heavily-indebted local governments, the central government will pay off some of their loans and state banks including some of the “Big Four” will be forced to take some losses on the bad debt, said the sources, both of whom have direct knowledge of the plans ….

Beijing will also lift a ban on provincial and municipal governments selling bonds, a step aimed at bolstering their finances with more transparent sources of funding.

Many analysts see China’s pile of local government bad debt as a major risk to the economy, especially as the economy slows, but few see widespread banking fallout as they believe cash-rich Beijing can step in to soak up losses ….

After a months’-long investigation into local government liabilities, Beijing has determined that local governments have borrowed around 10 trillion yuan, said one of the sources.

Chinese media have reported that the governments may default on around 2 trillion yuan worth of those loans.

While the move provides a boost to China’s major banks, questions do remain, says another Reuters report:

“We believe this would be a general positive for the Chinese banks as we consider their local government financing vehicles’ exposures to be the greatest risk to the banks’ credit quality,” Bernstein Research Analyst Mike Werner wrote in a research note.

China’s top banks provided many of the loans to local government vehicles as part of the massive economic stimulus programme launched by Beijing in late 2008 to counter the global financial crisis ….

“As part of the transfer, it is assumed that potential losses on this debt will be shared by the central government, the banks and the local governments themselves,” Werner wrote. Government assumption of the debt would take a bulk of the burden off the banks’ books ….

“The question right now on this plan is how the plan will be implemented, or if it will be implemented,” said Dorris Chen, an analyst at BNP Paribas in Shanghai.

“The previous clean-up was different because the government eventually got its money back from investors like you and me. It’s not sure how the government can get its money back this time.”


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