Leading Chinese Finance Official Calls for Conversion of Hidden Debt into “Statutory Debt” via Bond Issues

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A leading Chinese finance official has flagged the possibility of converting some “hidden” local government debt into “lawful” or “statutory” debt, following heightened efforts by the authorities to stymie risk in this area since the start of 2021.

Zhao Quanhou (赵全厚), chair of the Financial Research Centre of the Chinese Academy of Fiscal Sciences (CAFS), recently published a paper entitled “A Re-exploration of Methods for Dissolving Hidden Debt” (化解隐性债务方式方法的再探讨) in the journal “Local Financial Research” (地方财政研究).

The paper proposes that the Chinese government “appropriately allow some hidden debt to be converted into statutory debt, [thus] reducing liquidity risk,” as well as called for “exploring the appropriate extension of the timeframe for the dissolution of hidden debt of local government.”

In addition to his position at (CAFS), Zhao is also a member of the Fiscal Risk Research Expert Work Office (财政风险研究专家工作室) recently established by MOF.

Since 2017 MOF has stepped up efforts to regulate and dispose of hidden local government debt, starting with measures to contain its growth. Since 2018 a number of local governments in China have unveiled plans to fully dispose of hidden debt, setting timeframes of between five years to a decade for completion.

MOF has pointed out however that some local governments have continued to “raise debt illegally and in breach of regulations.” Since the start of 2021 MOF has repeatedly stressed the need to contain growth in hidden debt, as well as reiterated its position that “local governments are prohibited from increasing hidden debt in any form.”

Zhao calls for “correctly viewing the relationship that ‘one wanes as the other waxes’ that prevails between the statutory debt and the hidden debt of local governments.”

“While grasping overall debt risk, [we must] appropriately expand the vigour of statutory debt issuance in order to satisfy the reasonable debt financing needs of local government.

“When appropriate, [we] may appropriately expand policies for local governments to engage in conversion issuance of bonds, and use the method of increasing the leverage of statutory debt to make hidden debt apparent in a compliant manner, in order to ease financial risk in relation to hidden debt.”

Zhao also highlighted the importance of the cash flow state of hidden-debt finance projects, and the need for giving “comprehensive consideration” to the lifecycles of such projects.

“The full lifecycle of a significant number of hidden debt projects continues for ten years or longer, and for this reason it is best if we can match full lifecycles to cash flows when dissolving hidden debt.”

Zhao said that once growth in hidden debt and illegal financing are contained, outstanding hidden debt can then be dissolved by means of “systemic optimisation arrangements” that are based on the cash flows of projects and the interest and term structures of hidden debt. Some hidden debt can then be made subject to appropriate delays in repayment.

“Hidden local government debt is the product of many years of accumulation, and dissolving debt will also require time, otherwise it will be easy to worsen short-term liquidity risk in relation to hidden debt, as well as trigger other related risk.

“For this reason the dissolution of debt risk requires activeness and steadiness, proper control of pacing and effective control of flows.”

In recent years MOF has launched trials for the dissolution of hidden debt, allowing some local governments with developed hidden debt plans to issue bonds to swap out their hidden debt and extend repayment times, as well as reduce financing costs.

At the end of last year the finance department of Lucheng in the Zhejiang province city of Wenzhou announced that it was participating in one such trial, obtaining approval for 3.5 billion yuan in re-financing bonds.

Since the start of 2021 local governments around China have switched the purpose of their refinancing bond issues from the “repayment of principal on government bonds that have matured,” to the “repayment of outstanding debt” or the “repayment of outstanding government debt,” with analysts highlighting the likely inclusion of hidden debt in these amounts.

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