Debt Clampdown Compels Local Government to Renege on Bank Commitment Letters

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A clampdown on local government borrowing practices by Beijing is already having an impact on regional finance, putting authorities in the difficult position of having to withdraw from their commitment letters with banks.

While official data from China’s Ministry of Finance points to a significant drop in local debt volumes and ratios since the end of 2016, the same government body points to a rapid expansion in “covert debt,” prompting it to launch a crackdown on the use of public-private partnerships and government service procurement to engage in “hidden” borrowing.

One local debt officer said to 21jingji.com that “if our [official] debt level is 1, then the amount of debt raised via service procurements and PPP’s during period from the 2015 – 2016 would be 1.5 to 2.”

Despite the absence of authoritative data on covert forms of local government debt, domestic analysts contend that it poses significant risk to China’s financial system given the myriad forms it can assume, which include traditional bank loans, trust financing, government service procurement and PPP’s, as well as illegal guarantee methods such as government equity repurchase commitments or fixed yield commitments.

Keenly aware of the problem, at the outset of May the Ministry of Finance in conjunction with several other central government ministries and committees issued the “Notice Concerning Further Standardisation of Local Government Borrowing and Financing Conduct” (关于进一步规范地方政府举债融资行为的通知) (Document 50), which called for the rectification of local government use of financing guarantees by the end of July.

The directive required that all provincial governments establish government debt management teams, and arrange for thorough inspections of local government and local department financing guarantees.

According to the directive if local governments fail to effectively rectify their borrowing practices by the start of August, province-level governments would be responsible for pursuing relevant officials for liability.

The directive further stipulates that province-level debt management offices would be responsible for providing feedback on the matter to the Ministry of Finance, National Development Reform Commission and China’s leading financial regulators by the end of August.

The Ministry of Finance had previously revealed that it had previously uncovered the widespread use of commitment letters by local government to expedite financing, which is explicitly prohibited by China’s “Budget Law.”

A typical case might local government investment platforms borrowing money from a financial institution, and the corresponding local financial department issuing a commitment for the payment of the principal and interest on financial products, or a letter of commitment for the inclusion of the debt of the financial platform in medium and long-term budgets.

While the launch of the directive compelled local governments across China to withdraw or renege on their commitment letters in order to make the deadline, officials speaking to 21jingji.com say that this has not been a simple or easy matter to negotiate.

One local finance official based in eastern China said that during the process of negotiation, local branch banks are required to submit reports to their more central superiors, which can delay the process of withdrawal from commitments.

Some lenders have outright refused the unilateral proposal of withdrawal from commitment letters made by county-level governments, while other have required an increase in guarantee measures following the withdrawal, or even directly demanded pre-payment of loans.

Given that many of the banks involved are the branches of larger state-owned lenders, some local finance officials are requesting coordination with their higher levels to facilitate withdrawal from letters of commitment.

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