China's hidden $6 trillion debt pile is an 'iceberg' posing a 'titanic risk'
- Off-balance-sheet debt in Chinese local governments has ballooned in recent years and could now be worth as much as 40 trillion yuan ($6 trillion).
- According to analysts at S&P Global Ratings, this represents a "debt iceberg with titanic credit risks."
- Rising debt levels in China are a major concern for the global economy, with fears that a wave of defaults could be imminent.
China may be sitting on a hidden debt pile of as much as 40 trillion yuan ($6 trillion), concealed off-balance-sheet by the country's local governments, according to research from S&P Global Ratings.
Many local governments in China raise debt and hold it off their balance sheet, in order to avoid lending limits imposed by central authorities. S&P says that this is a growing problem within the country, and that the amount of debt held this way has likely ballooned in recent years.
"S&P Global Ratings believes the amount of debt that local governments keep off their balance sheets may be multiples of the publicly disclosed amount," analysts Gloria Lu and Linda Li wrote in a note on Tuesday.
"That's a debt iceberg with titanic credit risks," the analysts said, adding that including hidden debts, the "ratio of government debt to GDP could have reached 60% in 2017, an alarming level."
LGFVs have risen in popularity in recent years as a means of financing spending on a local level, following a dictat from Beijing limiting the amount that could be raised in local government bonds issuances. By using LGFVs, local governments are able to skirt round these rules and spend on infrastructure projects.
Not only is the level of hidden debt held by local governments in the world's second largest economy rising, but so too is the risk of those debts being defaulted on. Much of the debt is held by so-called local government financing vehicles (LGFVs), and S&P reports that central government may be willing to let these vehicles file for bankruptcy in the future.
"Default risk of LGFVs is on the rise. China has opened up the possibility of insolvent LGFVs filing for bankruptcy, but managing the default aftermath is a formidable task for top leadership," the report noted.
This bankruptcy risk has not gone unnoticed, with S&P cutting its credit ratings on seven LGFVs about a month ago. According to Reuters, Moody's Investors Service "downgraded five non-financial corporate and infrastructure issuers owned by governments in Tianjin, Jiangsu, Hunan and Hubei" at about the same time.
China's rising debt levels across all areas of its economy are seen as a major risk to global growth, with some analysts estimating that the next financial crisis could crystalize from the world's second largest economy.
The country's total non-financial sector debt, which includes household, corporate and government debt, will surge to almost 300% of GDP by 2022, up from 242% in 2016. Fears abound that if this debt pile continues to grow, a spectacular blow up could be imminent.
"Investor skepticism will return if policymakers take 'one step forward and two steps back' when the contagion of LGFV defaults emerges," the report said, referencing a major correction in the Chinese markets last time there were major concerns around debt levels in China back in late 2015 and early 2016.
"Clearly, the LGFV sector is a significant component of the Chinese corporate bond market and banking assets," it continued.
"On top of that, many shadow banking products related to LGFVs have been sold to retail investors. When financial and social stability is high on the agenda of China's top leadership, local governments and LGFVs are walking a tightrope."
Deeper fears stoked by deficit woes
Fears about Chinese debt are exacerbated by worries over the country possibly running a budget deficit for the first time in more than two decades this year.
China's current account balance is down significantly from last year's 1.3% and will likely turn into a small deficit in 2019. If so, that would be the first time in 24 years.
"The larger the stimulus used by China to offset the trade war impact, the bigger will its deficit likely be," UBS's Tao Wang, chief China economist, said in a report on Tuesday.
That may hurt confidence and hasten outflows, putting pressure on the nation's currency.
"Although CNY depreciation can partially offset trade war impact, a large depreciation will likely hurt domestic confidence, trigger panic outflows and risk financial stability," UBS said.