May 17, 2016 1:00 pm JST

China goes back to shadow banking

YUSHO CHO, Nikkei staff writer

SHANGHAI -- Chinese local government financing vehicles, which have been breeding ground for shadow banking, are staging a comeback.

If the current trend continues, it could raise concerns over the country's fiscal health.

The value of issuances for LGFV bonds -- also known as "chengtou notes" -- for the January-March quarter reached at least 588 billion yuan ($90 billion), its highest since the April-June quarter of 2014. With the scheduled issue from April through May 13 worth more than 300 billion yuan, the trend shows no signs of slowing down.

Founded by local governments, the financing vehicles are designed to engage in fundraising activities and infrastructure improvement. To counter the country's economic slowdown, local governments are desperate to find new financial resources. This could, however, worsen the country's debt problems.

Following the Lehman Brothers collapse at the end of 2008, Beijing rolled out a 4-trillion-yuan stimulus package -- which required local governments to foot more than half the bill. Due to a lack of resources, many local governments launched financing vehicles. They have managed to keep financing by issuing bonds backed by revenues from land sales.

However, the creditworthiness of LGFVs is far from certain and even the central government is said to be struggling to form a clear picture.

Many believe LGFVs have been less than prudent in issuing bonds in order to maintain short-term economic growth. The practice has increased their debts while creating a myriad of development projects in property and public infrastructure, which are now drawing weak demand.

In 2014, Beijing sought to curb the issuance of the LGFV bonds by giving the green light for provincial governments to issue their own bonds.

The decision was aimed at increasing transparency and holding down interest payments by taking advantage of government credibility. As a result, the value of LGFV-bond issuances fell below 200 billion yuan for the January-March quarter last year.

Meanwhile, local governments' debt rose to 16 trillion yuan at the end of 2015.

There is another headache. The country's real gross domestic product expanded 6.7% from a year earlier for the January-March quarter, the slowest growth in seven years. Given that the issue of municipal bonds has already topped 2 trillion yuan, issuers are less likely to test new offers. The resulting debt trap is leaving local governments no option but to increase dependence on financial platforms to avoid stalling the country's economy.

According to the International Monetary Fund, Chinese government debt accounts for slightly more than 40% of the country's GDP. However, LGFV debt figures and those of state-owned enterprises remain a very murky area and their impact is extremely difficult to gauge.

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