Trying to Understand China’s Ever-Enigmatic Local Government Debt (LGD) and Local Government Financing Vehicles (LGFV)


Few topics generate more confusion than the local government debt (or) LGD one, in light of the fact that bookkeeping has been horrendous to such a degree that… well, pretty much nobody can clearly state how much debt we are even talking about, with estimates ranging from 35% to 60% of China’s GDP.

At its core, the situation looks straightforward enough in that China’s total government debt is represented by local government debt on the one hand and central government debt on the other. While for the central government debt dimension, there is a quasi-consensus that we are looking at a figure in the 15% to 20% zone in terms of China’s GDP, the “spread” when it comes to local government debt estimates is far greater.


For quite a few reasons, for example the fact that technically speaking, local governments aren’t allowed to borrow in the first place. On the other hand, however, they are more than eager to finance a wide range of infrastructure-related projects and this led to “innovative” or “creative” vehicles being set up (Special Purpose Vehicles, or SPVs) such as so-called Local Government Financing Vehicles (LGFVs) through which legislation is essentially circumvented.

There is also the fact that the central government itself encouraged a wide range of spending to combat the effects of the Great Recession in China and as such, was more than eager to look the other way when it came to LGFVs and other SPVs for an extended period of time. While this changed as of 2011, with China deciding to tackle systemic risk (including or especially debt-related risk) and while programs such as the PPP one were introduced as of 2014 to allegedly bring in private investors who are interested in funding infrastructure initiatives, it all ended up being a bit of a charade in light of the fact that once Pandora’s (Debt) Box has been opened, it is difficult to put that genie back in its bottle and furthermore, many of the so-called private PPP investors were… well, fake, in an effort to once again bend the rules in true “grey area” fashion. At the end of the day, keeping track of a wide range of vehicles ends up being a Herculean task, which more than explains the very large differences among estimates.

All in all, a true administrative nightmare.

As time passed, China took its deleveraging (tackling the debt problem) initiatives to the next level and one might think that this brought about massive improvements on the LGD front. As strange as it may seem, the exact opposite happened in many situations. Why? Simply because tightening credit conditions represents awful news for over-leveraged local projects which were on the financially unsustainable side to begin with.

Furthermore, it is worth noting that most of these loans are short-term ones which mature in let’s say three years or less, short-term loans which (ironically) are meant to finance projects with longer-term outlooks. The end result can only be considered a rollover nightmare, especially in scenarios which revolve around interest rates going up.

On top of all this, we have the revenue dimension, which is unfortunately problematic for many local governments in light of the fact that for example land sale revenue has gone down, once again as a result of Chinese initiatives aimed at tackling real estate bubble-related risks. Add economic growth slowdown issues to the entire equation and needless to say, there are causes for concern.

Does this mean it is time to pack it up and leave?

Of course not.

Time and time again, the team has made it clear that it is long-term bullish on perhaps not “all things China” but certainly “most things China” and as a result, short to mid-term concerns on our part should not be treated as a deal-breaker. Instead, they represent the exact opposite: meaningful due diligence and proper risk management which is meant to ensure that we are on the right side of our long-term trades.

While we believe there is generation-defining potential in terms of the wealth which can (still) be built in China, we just as firmly believe investors and/or traders who sweep risk factors out of the rug due to excessive optimism will not have staying power. Just like the economic dominance of the United States did not come overnight, China’s ride will occasionally be bumpy as well.

Long-term bears see the occasional road block as a reason to proverbially pack up your bags and leave (perhaps even short Chinese assets heavily and never look back), whereas long-term bulls such as our team see it as an excellent buying opportunity or, if you will, the opportunity to load up on promising assets at bargain-basement prices while everyone else is panic selling.

Our occasional criticism needs to be viewed through this lens.

At the end of the day, if we take a step back and look at the entire government debt situation (government debt of which local government debt is a component), things don’t look as dire as they do in other countries. Also, we can compare the Chinese government debt situation to the Chinese corporate debt one, with it once again being obvious that if we are to choose what the proverbial elephant in the room is, corporate debt rather than LGD + CGD would be it.

Two words: dosage and context.

An investor and/or trader who know how to identify risk factors properly and include them in his or her risk management equation in the proper “dose” will do well. On the opposite end of the spectrum, investors/traders who over-prepare will end up lost in a “paralysis by analysis” framework on the one hand, whereas overly-optimistic to the point of reckless investors/traders will be caught off-guard time and time again. “Balance” is the operative word and in the spirit of just that, the team is at your disposal should you need our assistance with respect to putting together a coherent as well as balanced risk management framework.

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