The complexities in measuring China’s public debt cannot mask growing concern on LGFVs

With ballooning COVID bills and?vanished land sales revenue, global investors are concerned about China’s public debt, especially after the recent last-minute scramble by Kunming (the Yunnan province) to repay its local government financial vehicle (LGFV) debt. There are broadly three types of China’s public debt, issued by central government, local governments and LGFVs. The first two are "on-balance sheet" debt, meaning governments fully recognize them. While central government debt is always tightly managed, local government debt already faces stresses. However, what is more important is about how far LGFVs have gone, which are considered as "off-balance sheet" debt and mainly used to finance infrastructure and real estate projects and separate its funding from general tax revenue.

Data accessibility to gauge local governments’ off-balance sheet debt, i.e., LGFV, is difficult as there is no clear definition of such entities. In this note, we aim to provide a better understanding of its evolution. This will enable us to better gauge China’s total public debt until Q1 2023. Regarding the data source, we abandoned Bloomberg's LGFV data as it halted LGFV classification in January 2022. This report, thus, builds on WIND's (a data provider in China) LGFV data from bank loans or bond issuances. Our revised estimate shows China’s LGFV debt grew consistently between 2017 and 2019 with a further acceleration since the pandemic. By now, LGFV-related public debt is closer to the sum of central and local government on-balance sheet debt.

A conversional way to measure debt is the debt-to-GDP ratio, and the denominator (GDP) grew slowly between 2020 and 2022 further increased the fiscal burden. In fact, even after the government pivoted away from the zero-Covid policy in end-2022, China’s public debt continued to rise in the first three months of 2023. If we include off-balance sheet (LGFV-related) borrowing, China’s public debt increased from 95% of GDP in Q4 2022 to 97% of GDP in Q1 2023.

Internationally, China’s public debt-to-GDP ratio is still lower than that of the US (120% of GDP in Q4 2022) but higher than the Eurozone (92% of GDP in Q4 2022). However, our estimates have three limitations. First, this comparison misses the other types of China's state-owned enterprises (SOEs) debt. Second, our “off-balance sheet” public debt estimate relies on the public disclosure of the LGFVs’ financial statements, which might be incomplete. Third, our overall estimate of China’s local government debt cannot be compared with that of the IMF as we do not include government guided funds due to limited public data disclosure.

Notwithstanding these uncertainties, an alleviating factor for concerns about China’s debt is that it is mostly domestically owned, i.e., held by China’s residents. This means China’s government can reshuffle resources to achieve debt sustainability, either through lowering interest rates or even monetizing debt, if needed. However, the rapid accumulation of public debt may weigh down on potential growth rates over time as it further affects the efficient allocation of resources.

While we expect China’s public debt burden to increase further, weighing down on potential growth, debt sustainability may not be a problem. Still, among all types of public debt, LGFV debt could be particularly concerning as these vehicles may not have an explicit official guarantee from the central or local governments.

Full report is available for Natixis clients.