Xi is fattening up China's debt "gray rhino", Plus Europe is "backing away" from Xi's Belt-and-Road & US hunts for PRC malware in military systems -- China Boss News 8.04.23
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What happened.
Last week South China Morning Post’s Amanda Lee reported on China's local government debt and why it has become a "gray rhino" for Beijing.
Local governments whose access to financing had been restricted in the ‘90s by budget laws created local government financing vehicles (LGFVs) as a “workaround.” The pseudo-private investment companies (“hybrids”) had more freedom to take advantage of emerging commercial opportunities, unhampered by Beijing’s borrowing rules.
The move was actually encouraged by Beijing, who had “been pushing many LGFVs to diversify, hoping they could generate more revenues and depend less on local government coffers,” Chi Lo, a BNP Paribas Senior Market Strategist for Asia Pacific said in a report on the risk of hybrid LGFV defaults in May.
Unfortunately, hybrid LGFVs “have become more fragile due to excessive risk-taking and poor risk management,” Lo warned. Worse, “Beijing views hybrid LGFVs as more dispensable than quintessential ones.”
The commercially diversified nature of hybrid LGFVs means they function like (local) SOEs. As Beijing retreats from its implicit guarantee policy, which has resulted in rising defaults in recent years … it has allowed (local) SOEs to fail in the hopes of imposing market discipline on the state sector to reduce moral hazard.
Hybrid LGFVs are thus not on the bailout priority list and will have to deal with their debt obligations on their own rather than count on the local or central government.
Why it matters.
Fattening the calf
Easy access to financing at state-run banks coupled with growth goals made LGFVs very popular with officials in the provinces and cities who used them to meet administrative and career goals.
Lee, SCMP:
LGFVs were actually a cornerstone of Chinese development over the last few decades. . . . There are now thousands of such vehicles in China, driving investments in bridges, roads, homes and industrial parks, and boosting the country’s gross domestic product (GDP).
But alongside unprecedented positive development, came unprecedented waste.
Stories of fiscal recklessness shocked even Chinese citizens used to seeing government excess. (One about a small, rural county in poorer Guizhou that “rack[ed] up 40 billion yuan ($5.7bn) in debt with dozens of white-elephant projects” got 27 million views on social media.)
Then, in 2017, Chinese leader Xi Jinping took a firm step towards ending the feverish market speculation that made housing unaffordable the only way he knew how - by breaking the backs of its biggest high rollers.
In October that year, Xi uttered the words that would guide government policy until now: “Housing is for living in, not for speculation.”
Soon after, the government launched a $1.3 trillion real estate crackdown that "left few winners," Bloomberg said.
Xi’s “politically acceptable” property bail-out
By September 2022, however, things were very different. Although LGFVs traditionally invested in public infrastructure, they went on a new kind of debt-fueled "spending spree" designed "to prop up the real estate sector” which had been blindsided by, both, Beijing and Covid, Financial Times reported at the time.
FT:
A plunge in land sales and softening prices have exacerbated the pressure on local governments already grappling with shrinking tax bases amid the wider economic downturn. This has led many cities and provinces to ask LGFVs to fill the vacuum left by private developers.
“We have played a critical role in keeping the land market and government revenues from falling off a cliff,” said an executive at Yueyang Urban Construction and Investment. The LGFV, based in central Hunan province, spent Rmb1.3bn on land purchases in the first half of [2022].
With only weeks remaining until Xi would be appointed to an unprecedented third term at the 20th Party Congress, China’s local governments again gorged themselves on eye-watering levels of debt in what one expert described as “a politically acceptable” bailout.
Now those same LGFVs, who “typically have little experience in property development” and “are known for their sluggish financial performance” are faced with paying back their debts while China’s economic growth stalls.
The IMF estimate of LGFV debt “ha[s] swollen to a record 66 trillion yuan (US$9.23 trillion) this year – more than doubling since 2017, when the total was 30.7 trillion yuan,” SCMP’s Lee said. In 2017, China’s economy grew by nearly 7%. However, Fitch anticipates growth will slow to 5.6% in 2023, 4.8% in 2024 and 4.7% in 2025.
Where “central planners rule”
That China's fiscal administration today is, often, described as one of the most de-centralized in the world is misleading.
Although Deng Xiaoping famously opened China to foreign investment and created “special economic zones,” early post-Mao attempts at fiscal decentralization failed to put most local governments on "a self-financing basis," according to Christine P.W. Wong at the National University of Singapore.
The reason, Wong says, is because “the old fiscal order was thrown into considerable disarray by the elimination of control of entry into industry, a mechanism through which the government had exercised control over the creation and placement of revenue surpluses.” In other words, the Chinese government, including Beijing, was about to go broke.
A 1994 VAT rule significantly improved the state’s finances, but made local governments increasingly dependent on state-owned banks to meet their expenses.
Nicholas Borst, director of China research at Seafarer Capital Partners, told SCMP that China’s current leadership would be “reluctant to change the fiscal structure because it gives Beijing significant financial control over the provinces.”
“The policy direction under Xi Jinping is towards greater centralization and reinforcement of state control over key parts of the economy. Fiscal reform would likely cut against both of those tendencies,” he added.
Xi’s return to Mao-era mass mobilization governance has only compounded the problem. One example can be seen “[i]n a growing list of places” where local cadres are answering his calls for food security “with more zeal than common sense,” the Economist’s Chaguan said last week.
In Xi Jinping’s China, central planners rule, The Economist:
In and around Chengdu, the capital of Sichuan province, officials are focusing on Mr Xi’s current priority. That means growing grain. They are making their obedience visible. Mr Xi visited the fertile Chengdu plain last year, recalling how it was known in history as “heaven’s granary”. Those words, along with Xi-isms about food security and cropland, now appear on village walls and roadside propaganda posters.
Another of Xi’s top priorities is to win the tech-war with the United States using “‘high-quality’ growth, a strategy that favors tech industries over the vast manufacturing hubs that churn out basic consumer goods,” Financial Times recently reported.
Yet factory activity - which is currently in its fourth month of contraction - was “one of the pillars” which supported China’s economy during the worst of the pandemic.
Worrisomely, Robert Carnell, ING’s regional head of research for Asia-Pacific, said China's poor manufacturing purchasing index (PMI) data is the latest evidence its economic recovery is not "turning the corner.”
Carnell noted that the Chinese government’s vocal support for the economy “has not translated into the sort of sizeable fiscal policy stimulus many in the market have become used to expecting.” “We don’t think it is coming,” he said.
Earlier this year, local governments began "doubling down on cash incentives and policy support for home-grown semiconductor companies," as TechWire Asia reported.
The old LGFV term has a lot of land investment baggage, and so they called the new scheme something entirely different. But is it? To answer that, you should read more about the Big Fund.
TechWire Asia:
Announced over the weekend, local authorities in Guangzhou said 150 billion yuan would be injected into an Industry Investment Fund of Funds (FoF), focusing on financing activities in semiconductors, renewable energy, and advanced manufacturing. An FoF, designed to allocate cash to a portfolio of investment funds, is increasingly used by Chinese local governments to develop preferred industries.
. . . Guangzhou’s latest initiative is basically in line with calls made by China’s leadership to help revitalize the country’s beleaguered private sector during the 20th Party Congress last October.
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The Big Story in China Business
EUROPE “BACKING AWAY” FROM BELT AND ROAD: Europe is "backing away" from Chinese leader Xi Jinping's Belt and Road Intiative, amid tensions with China and Russia's war in Ukraine, Wall Street Journal reported last week.
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