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China in Focus: Reducing China's debt burden

11 Sep 2023

Key Takeaways

  • Recovery momentum continued to ease while services and related consumption remained the bright spot
  • We look at options for China to reduce local government debt levels including refinancing infrastructure projects

China data review (July 2023)[@source-wind-hsbc]

  • Retail sales grew at 2.5% y-o-y in July (from 3.1% in June). The summer travel period helped to boost services and related-goods demand when looking at the 2-year annualised returns: catering sales rose 6.8% and tobacco, alcohol and beverages grew faster than the previous month. However, property-related consumption stalled as construction and decoration materials dropped 9.5% and furniture was 3.2% lower, based on the 2-year annualized returns.
  • Industrial production growth slowed to 3.7% y-o-y in July (from 4.4% in June),as manufacturing activity eased. The weakness was mainly from sectors such as general equipment (-1.4% y-o-y) and electronic equipment (0.7% y-o-y). But,some upstream categories such as ferrous metal (15.6% y-o-y) and non-ferrous metal (8.9% y-o-y) smelting and processing remained solid, likely driven by the likes of housing completions and electrical vehicles.
  • Fixed asset investment eased in July, to 1.2% y-o-y (from 3.1% in June).Divergence across the major investment components persisted with property investment falling 12.2% y-o-y and private investment down 2.4%, contracting for the fourth consecutive month reflecting still muted confidence in the private sector. However, infrastructure and manufacturing both grew in July, at 6.5% and 4.3% respectively, although moderating from June.
  • CPI and PPI inflation both contracted in y-o-y terms, though the dip in the former is likely to be only temporary. CPI fell by 0.3% y-o-y although underlying consumer strength showed some signs of pick up as CPI rose sequentially for the first time in 6 months, up 0.2% m-o-m. Core CPI also saw a notable improvement, rising by 0.8% y-o-y. But, PPI deflation moderated, falling 4.4% y-o-y due to some fading of base effects and higher global commodity prices.
  • Exports fell by 14.5% y-o-y in USD terms, continuing a second month of double-digit declines on the back of still weak global demand. Ongoing policy tightening by other central banks as well as the rotation towards services consumption have continued to weigh on demand. Meanwhile, imports fell by 12.4% y-o-y in USD terms, as the domestic recovery has yet to broaden out, partly reflective of still weak household and business confidence.

Reducing China’s debt burden

As China transitions towards higher-quality economic growth, it is moving away from the old playbook of loading up on more debt to invest in property and infrastructure to spur short-term growth. However, local government financing vehicles (LGFVs) have amassed large amounts of debt in recent years (chart 1), with complex interlinkages to other entities, so there are potential repercussions to the wider economy if they suffer financial distress.

Source: BIS, Wind, HSBC estimates
A debt restructuring plan can help alleviate financial strain

Hence, a comprehensive debt restructuring plan may be needed to tackle different aspects of this problem, as mentioned in the July politburo meeting. Based on successful historical precedents, we envision that the plan could compose different measures to address different types of debt, which depend on the purpose of borrowing and project nature. These include:

  • Debt on non-bankable infrastructure assets (projects which prospective lenders consider an unacceptable level of risk): swap the higher-cost funding from LGFVs into government funds/grants, treasury bonds or local government bonds
  • Debt borrowed to fund bankable infrastructure assets: development banks could help to refinance higher-cost borrowings, infrastructure trusts could bundle portfolios of projects with regular cash flows and bring in new capital from investors, and the central government may consider granting more local government special bond quota (currently only permitted for provincial governments) or allowing lower-level governments to issue revenue bonds
  • Non-infrastructure / non-public services related businesses: may be transformed into general state-owned enterprises (SOEs), and no longer receive implicit government guarantees
  • Engage distressed asset managers to oversee and handle non-performing assets
  • Monetise local government ‘idle assets’ (worth over RMB40trn, according to the Ministry of Finance) to generate cash flow to meet short-term liquidity need
Future investment projects may adopt best practices

For future infrastructure investments, China may aim to adopt best practices in infrastructure investment from the outset. That way, projects could be planned, executed, and managed in a way that maximizes efficiency, effectiveness, and be sustainable longer term. Careful project lifetime planning could mean better alignment in terms of spending and resources, and help to build healthier intergovernmental fiscal relations. Fiscal reform may also involve more central oversight on local and provincial government finances.

Local governments may seek new revenue streams

Along with the structural transition towards higher-quality growth, there is now reduced demand for infrastructure projects. This, to some extent, helps alleviate the pressure on local governments arising from reliance on land sales as a funding source. Yet, it is crucial for local governments to actively seek alternative revenue streams, as they increase public investment in soft infrastructure such as a social safety nets, including better unemployment benefits, and granting migrant workers access to public healthcare and public schools.

Source: Refinitiv Eikon
* Past performance is not an indication of future returns Source: Refinitiv Eikon. As of 29 Aug 2023 market close

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Disclosure appendix

Additional disclosures

1. This report is dated as at 30 August 2023.

2. All market data included in this report are dated as at close 29 August 2023, unless a different date and/or a specific time of day is indicated in the report.

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