China’s economy is facing a significant challenge as it attempts to address a USD 13 trillion debt crisis predominantly linked to local government financing vehicles (LGFVs). The issue has gained attention despite the ongoing property crisis in China. The LGFV debt, mostly off-balance-sheet, is almost equal to China’s annual GDP.
This concern arises from the escalating default drama among large property developers and the proliferation of LGFVs. Global investors express apprehension about China’s economic stability, particularly during a period of extreme global uncertainty.
However, the Chinese Communist Party seems determined to address this LGFV debt crisis, as indicated by upcoming discussions scheduled for July 15-18. During this economic strategy session, Xi Jinping’s inner circle plans to formulate a solution to the massive LGFV debt pile.
The impending Third Plenum aims to allow local governments to keep more of the fiscal revenues they generate, currently sent to Beijing. These tax reforms could significantly reduce the threats to financial stability and provide local governments with greater scope to invest in high-value sectors.
This shift in funding structure could boost domestic consumption and move China towards sustainable growth, instead of rapid expansion. The need for reforms is urgent as regional leaders have relied on heavy infrastructure development to fuel economic growth in the past, leading to an infrastructure arms race.
Now, the cost of this buildout is becoming due, placing considerable financial pressure on local governments. Historically, LGFVs have played a crucial role in financing China’s massive infrastructure projects. Despite these problems, the return on LGFV assets has typically remained low, and these debt issuances continue to constitute a significant portion of fiscal spending.
In the upcoming discussions, there is a possibility of enhancing China’s capital markets and empowering local governments to implement policies aimed at promoting economic growth equitably. Experts believe major changes could occur in China’s fiscal system, marking a turning point in Xi Jinping’s economic reforms.
