The Chinese government will permit as much as 1 trillion yuan of high-yielding debt to be swapped into local-government notes that have lower yields, the finance ministry said on March 8.
The amount represents 53.8 percent of the total local government debt maturing in 2015. However, the swap will only be allowed in replacing debt that is due within this year. And local authorities are required to meet the repayment obligations on the debt instruments they’ve issued..
Nevertheless, the initiative will help ease their massive debt burden without crippling the broader economy. The debt burden varies from region to region, and different banks also face different situation. In some regions, local banks have financed over 50 percent of local government debt.
The issue is: who will pay the bill for local government debt in the end? The debt swap plan has been rolled out in a bid to avert liquidity crunch in local governments’ under-construction projects. More importantly, the move will optimize the debt profile and reduce interest rate costs, which will prevent default for some local governments.
In addition, the swap plan will enable local financial institutions to spare some liquidity for companies or industries that badly need credit.
Debt conversion will greatly reduce the market’s current worries over local governments’ refinancing risks.
The debt swelled to 17.9 trillion yuan as of June 2013, according to data compiled by the National Audit Office. And the liabilities falling due in 2015 has reached 1.86 trillion yuan. However, the swap plan will allow borrowers to extend the maturities on their debt, and it won’t increase the government deficit for this year.
The restructuring does not reduce the vast debts, but it does make it much easier to bear. Different local governments will be granted different proportions based on their debt maturities and debt ratios.
The swap from local government financing vehicle (LGFV) debt to municipal or provincial debt will also make it clearer who has ultimate responsibility for the debt. The debt swap has different usage compared with LGFV debt, which has been issued to supplement funding for public projects.
What interests the market is the percentage of bank loans in LGFV debt. For example, China’s eastern Zhejiang province announced on January 24 that various local governments have total liabilities of 508.82 billion yuan as of June 2013. Of this, debt for which local governments issued official guarantees reached 32.71 billion yuan while debt for which local governments might shoulder some of the rescue burden reached 151.3 billion yuan.
An analysis has shown that bank loans fund 56 percent of the debt for which local governments issued official guarantees, while debt issuance and trust financing represents 15 percent respectively.
The debt restructuring will benefit mainland banks by reducing the ratio of bad assets and mitigating debt burden and default risks. The new instrument has better transparency and terms, which may help banks manage their asset quality.
However, the investment returns from high-yielding obligations are set to fall back, a phenomenon that may have an adverse impact on some banks and financial institutions.
This article appeared in the Hong Kong Economic Journal on March 16.
Translation by Julie Zhu
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