China may have to face a huge hidden debt, with potentially catastrophic consequences, following the boom in infrastructure projects scattered across the various Chinese provinces.
S & P Global warns of potential risks related to Chinese debt.
According to the report by S & P Global, local governments have accumulated a pile of hidden debts (between 5.5 and 6 trillion dollars), following the rampant Chinese growth.
The growing debt of the so-called local government financing vehicles (LGFV) constituted 60% of the Chinese gross domestic product at the end of last year and this is expected to lead to an increase in defaults by companies linked to small governments across the nation.
For many years, local governments have not been allowed to increase debt in capital markets, and so they have used other tools to finance infrastructure projects, often working under pressure to achieve high growth rate targets. LGFVs were the main tool for financing these projects and a key factor for Chinese economic growth.
While local governments have been more recently authorized to issue bonds, and the central government has tried to suppress off-balance sheet financing, the LGFVs have remained active in building large amounts of debt, often through opaque funding channels.
According to S & P Global, it was not easy to measure the debt as it was submerged, adding that the amount of debt that local governments kept out of the balance sheets could be a multiple of the publicly disclosed amount, around 40 trillion RMB, or perhaps even more.
The exact amount of debt is not known because much of it is not in local government budgets. Instead, a local government could have numerous LGFVs, hiding the total amount and making it difficult for central regulators to offset the debt. Most debts are held by small or medium-sized local banks.
China’s economic growth is expected to slow in the coming years. GDP is expected to grow by 6.6% in the third quarter of the year, down slightly from the previous quarter, according to a consensus from Reuters analysts. Data on GDP for the period will be reported on Friday.
The government is also pushing through rigorous banking reforms that have made access to credit more difficult through off-balance sheet channels. At the same time, a trade war between the United States and China is expected to erode economic output in the coming months.