China's economic troubles have been making headlines recently, with concerns ranging from deflation to record youth unemployment and a deepening property crisis. However, a lesser-known but equally significant issue is emerging: China's hidden-debt problem.
China's local governments have accumulated a large amount of debt, primarily to fund regional infrastructure projects. These debts are known as local government financing vehicles (LGFVs) and are considered off-the-books lending by the Chinese government. Estimates suggest that the outstanding obligations of LGFVs are close to $10 trillion.
The LGFV sector has grown rapidly since the 2008 global financial crisis, as the Chinese government aimed to support infrastructure and public services to sustain economic growth. Bloomberg and the International Monetary Fund estimate the total value of LGFV debt to be over $9 trillion, with local governments' bonds totaling about $2 trillion. Any defaults on this debt would have a significant impact on China's financial system.
The mounting stress in the LGFV sector is reminiscent of the crisis in China's real estate industry, which began in 2021 and has had global repercussions. While no LGFVs have defaulted on their debt yet, the sector's struggles are raising concerns among investors and banks are becoming reluctant to lend. Viable projects are also becoming harder to find.
The success or failure of local government debt restructuring will be a crucial factor for China's economic growth in the coming years. However, Beijing has refrained from intervening in the sector to encourage self-sufficiency.
The potential consequences of the hidden-debt problem are significant. A collapse in local government investment could have an economic impact comparable to the property market crisis. China's property sector accounts for about 30% of the country's overall output. Headwinds faced by the sector, such as heavy debt burdens and sluggish demand, have already contributed to lower-than-expected GDP growth.
The implications of China's hidden-debt problem extend beyond its borders. Any turmoil originating from this debt would send shockwaves throughout the global economy. As China grapples with its economic challenges, attention will be focused on how the government addresses these issues and manages the risks associated with hidden debt.