China’s economy needs swift action to avert local government debt disaster

Together with a forceful stimulus to revive growth, a smart approach to defuse China’s local government debt bomb could go a long way towards reducing systemic risks of the financial system, lessening the burden of the economy and restoring the confidence of investors

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Local government financing vehicles have been the go-to platforms for local governments to secure off-balance borrowing for infrastructure projects for years, but the amount of hidden debt they carry makes them a particular concern at a time when local government finances are under heavy scrutiny. Photo: Xinhua

Aidan Yao

Aidan Yao is a senior investment strategist for Asia at Amundi, based in Hong Kong.

Published: 3:45pm, 11 Jul 2023

Growing speculation around attempts to shore up local government finances suggests that Beijing is finally starting to tackle one of the chronic ills in the Chinese economy. Local government debt had swollen to almost 38 trillion yuan (US$4.8 trillion) at the end of May this year.

More worrying is the hidden debt amassed by a vast number of local government financing vehicles (LGFVs), which surged to a record 66 trillion yuan at the end of last year, according to the International Monetary Fund. That is equivalent to about half of China’s GDP. There are several aspects of this growing debt pile that pose challenges for China’s economic and financial stability.

The first aspect is the debt pile’s rapid growth. Before the 2008 global financial crisis, local governments tended to run conservative budgets and had little debt, but this changed as they and their LGFVs played an important role in the post-crisis economic recovery. In 2015, the Ministry of Finance carried out a debt swap that replaced local government liabilities with more transparent and lower interest bonds.