Wang Qian: Risk and management of local debt problems

Source: FT Chinese Network

It is recommended that local governments set up a pool of preventive funds for preparing for default, and when their explicit debts are at risk, activate the preventive capital pool as a source of funds for repaying explicit debts to reduce the occurrence of default risk events.

Wen 丨 Wang Qian Associate Professor, Tongji University, FRM

In recent years, active fiscal efforts have continued to exert force, and local government debt has expanded significantly. According to flush data, as of June 2023, China's local government debt balance was close to 38 trillion yuan, of which the balance of local government general debt was 14.8 trillion yuan, the balance of local government special debt was 22.9 trillion yuan, and the balance of local government bonds was 37.6 trillion yuan.

Resolving local debt risks requires all parties to strengthen overall coordination. The recent Politburo meeting stressed the need to effectively prevent and resolve local debt risks and formulate and implement a package of debt plans. People's Bank of China. The State Administration of Foreign Exchange proposed at the second half of the work conference proposed to coordinate financial support for local debt risk resolution.

In recent years, local bonds have maintained a large issuance and the balance of bonds has continued to expand. At present, the scale of China's local government bonds should be a controllable situation at the international level.

As of last month, the issuance of new special bonds in China remained in a manageable range. For example, in January 2023, the issuance of local government bonds was 755.354 billion yuan. Compared with the same period last year, this level is lower than the same period last year of about 450 billion yuan. In 2018, for example, Chinese local governments issued a batch of new special debts with a maturity of 5 years, which coincided with the payment period this year. The vast majority of such debts require local governments to raise new debts to pay off old debts. This has undoubtedly put greater pressure on the finances of local governments.

From the perspective of debt ratio and debt balance growth rate, local governments such as Qinghai Province and Tianjin Municipality have relatively prominent explicit debts, and their debt issuance scale and debt degree are relatively large.

Under the slowdown in economic growth and the deep adjustment of the real estate market, the comprehensive financial strength of some places has weakened, coupled with the expansion of explicit debt balances, and the pressure of debt and interest repayment seems to be difficult to avoid. The explicit debt pressure of local governments and its changing trend are increasing and cannot be ignored.

As we mentioned earlier, the expansion of local governments' explicit debts has increased the pressure on them to repay principal and interest, which has prompted local governments to take on new debts and repay old debts. At present, the credit risk of China's debt market is high, and since 2021, large-scale debt defaults have occurred, and the pressure to re-borrow and issue new debt is increasing. From various perspectives, local explicit debt, such as special debt, is facing higher financial risk pressure. Combined with the credit risk of China's credit market in the past two years, the degree and scale of risk show a trend of increasing risk.

So, what problems and hidden dangers may be brought about by the generalization of special debt? Under normal circumstances, the types of credit risks contained in government investment and financing platforms include: credit risks brought by bond products to investors; credit risk of loans; and the credit risk of the trade-to-home space. The current trend is that local governments are expanding the issuance of special bonds to protect local finances. What needs to be noted here is that it is necessary to control the issuance of local debt within the scope of local fiscal capacity, prevent excessive borrowing, prevent large-scale default of local debt, and prevent the credibility of local governments from being negatively affected.

From the perspective of China's current stock, the potential financial market contagion risk caused by it has a high probability. On the one hand, China's current financial market volatility is high, and financial markets and financial institutions are facing structural operational problems; On the other hand, the debt of local governments themselves is not limited to the issuance of special bonds that we mentioned here. Once the financial market is triggered by financial risks, various forms of liabilities of local governments will not only directly have a negative impact on the risk status of their own fields, but also spread to the macroeconomic field, the government financial field, and then extend to the entire national economy and financial system with the help of risk contagion channels. If the issue of local special bonds is not properly handled, in the current environment of high financial risks, it will have a risk trigger effect on the entire macroeconomy and financial market.

Regarding giving better play to the role of local debt in supporting economic construction, as well as preventing local explicit debt risks and promoting the high-quality development of local bond markets, the author suggests that in terms of the current risk situation of China's financial market, as far as the current local explicit debt risks are concerned, we need to raise credit risks and financial contagion risks to the warning line. This requires local governments to effectively control the level of debt, strictly control the scale of debt, and at the same time strengthen risk management in the field of debt, especially when encountering credit risk, concentration risk and financial contagion risk, etc., prepare countermeasures, strictly prevent the occurrence of default, and control risks such as default in the security field. We suggest that local governments now begin to set up a pool of preventive funds for preparing for default, and when their explicit debts are at risk, activate the pool as a source of funds to repay explicit debts and reduce the occurrence of default risk events. At the same time, it should be noted that from now on, the continued issuance of explicit debt should be strictly reduced and controlled.

Recently, some experts mentioned that under the pressure of land finance, urban investment companies are strapped for funds, which has led to the resurgence of local triangular debt problems. Referring to historical experience, local triangular debt may have some adverse effects on regional economic and financial operations. The harm of triangular bonds to regional economic and financial operations is very significant. Its core harm is the risk of financial contagion, that is, the credit default of an enterprise leads to the credit default of an affiliated enterprise. Especially when the scale of credit default is large to a certain extent, the risk of financial contagion has a devastating negative impact on the financial system. The financial crisis that swept the world in 2008 was the scourge of financial contagion. It's just that one is in the field of financial derivatives, and we are talking about the field of debt, in the field of the national economy. The adverse effects of the latter are more pronounced and severe.

As a response to the above problems, the author suggests that several core methods to manage the risk of financial contagion are to strictly control each single link without credit risk and financial risk. Secondly, the reserve system for storing risks is stored, and when financial risk losses are to occur, the reserve system is used to prevent the occurrence of defaults and prevent the expansion of the scale of financial risk destruction. In addition, we propose to establish an early warning system to prevent the occurrence of risks, set thresholds, warn of different stages of risk occurrence, such as different threshold spaces, warning, early warning, prevention of the occurrence of financial risks, when the risk reaches each degree of early warning, according to the degree of early warning, make appropriate countermeasures. Finally, it is necessary to prevent the concentration of such triangular debt risks, and from now on, effectively diversify the risks of the current triangular debt.

The views expressed in this article are those of the author only.