1 Kunming’s LGFV woes epitomize local gov’t debt risks
May 22
The fixed income team at Haitong Securities Research Institute held an online meeting on local government financing vehicles (LGFVs) in Kunming City, the capital of Yunnan Province. During the meeting, an employee at the Kunming branch of China Minsheng Bank shared the city’s problems with servicing municipal investment bonds, including local government funding issues, funding availability, debt management, etc. (see next section). Those details were widely circulated on the internet via a document titled “Minutes of a Meeting of Kunming City Investment Bond Experts” (昆明城投專家會議紀要), causing widespread market concern.
On May 24, the Kunming State-owned Assets Supervision and Administration Commission said that “some online media” had disseminated “false information” about the city’s municipal investment bonds, impacting local state-owned enterprises and related parties. Kunming’s state-owned assets manager added that legal action was being taken to protect the city’s reputation.
Meanwhile, Haitong Securities said in a statement that the remarks made by external participants at the meeting it organized do not represent the views and positions of the company. The Kunming branch of Minsheng Bank also issued a statement condemning the “negative impact” of its employee’s behavior and said the situation was dealt with “seriously in accordance with the relevant regulations.”
May 23
Information circulating on the Chinese internet claimed that funds from Kunming’s local social security fund and provident fund were used to help Kunming Dianchi Investment make a last-minute payment on a 1 billion yuan note (“22 Dianchi Investment SCP003”) that matured on May 21 (delayed to May 22, which is a working day). Kunming Dianchi Investment is a Kunming government LGFV, and also operates sewage disposal and pollution treatment.
According to data by Wind, Kunming Dianchi still has five bonds yet to mature with a combined 4.12 billion yuan in principal. Three of those bonds worth 2.5 billion yuan are due this year, according to mainland media and the meeting minutes. However, Kunming Dianchi’s quarterly report states that it only has 351 million yuan of cash as of March 31.
Online meeting minutes
The “Minutes of a Meeting of Kunming City Investment Bond Experts” revealed the following details about Kunming’s LGFV debt crisis:
- The LGFV Kunming Land Development and Investment Management sought funds from the Kunming local government to make payments on a maturing municipal investment bond. Of the funds provided by the local government, 140 million yuan was obtained through other Kunming LGFVs taking illegal loans from the Bank of Communications.
- A Kunming vice mayor brought the chairmen of three LGFVs with him to borrow money from Shanghai LGFVs. The Kunming authorities and LGFVs turned to Shanghai LGFVs as opposed to the Shanghai authorities because the latter was affected by the COVID-19 pandemic in 2022 and was not able to transfer the hundreds of billions of yuan that it would send each year to support Yunnan.
- Several Kunming LGFVs that investors found to be sound (i.e. creditworthy) had been unable to make wage payments for three to four months and had defaulted on payments to suppliers. Those LGFVs had their bank loans rolled over, with payments on interest and principal to be made only in 2024 or 2025.
- Extended bank loans of Kunming LGFVs are not being counted as non-performing loans and will be rolled over when they are due but payments have not been made.
- Kunming has more than 20 billion yuan worth of LGFV bonds maturing in the second half of 2023. Kunming is now facing debt pressure from the open market and its non-standard debts are basically overdue. Also, there are too many debtors in Kunming and the situation is tough to handle, with the possibility of “all the pieces [LGFV debt risks] blowing up [defaulting].”
- Kunming LGFVs have not been going to Beijing, Shanghai, and Shenzhen to promote their bonds because there are no projects to do, there are no benefits (of buying the bonds) worth talking about, and the cost of reissuing bonds is too high.
- The Yunnan provincial government drained a lot of corporate capital in 2022 to pay off Yunnan Health and Cultural Tourism Holding Group (雲南康旅; formerly known as Yunnan Metropolitan Construction Investment Group [雲南城投]) debts (which could not be rolled over anymore) and faced interest rates of about 7.6 percent on ultra-short-term financing. As a result, a Yunnan vice governor indicated at a financial conference that the province will no longer make available funds to bail out LGFVs.
- Yunnan provincial-level LGFVs have stopped issuing many bonds and will not issue new bonds if there are no particularly urgent projects.
- The Yunnan provincial authorities requested at the start of the year that there cannot be any material default on public debt. Separately, all national-level commercial banks (with the exception of state-owned banks) had instructed their Yunnan branches not to invest in local LGFV bonds. Local commercial banks that operate in Yunnan are allowed to invest in LGFV bonds, but Yunnan LGFVs owe a lot of debts to banks in the province after having helped to pay off Yunnan Health and Cultural Tourism Holding Group’s debts.
- Yunnan and Kunming authorities have issued a lot of special government bonds, but there are not many projects ongoing and the bulk of the funding raised appears to have been diverted to repay debts.
- Kunming LGFVs were enlisted to buy land so that the Kunming authorities could “generate” revenue to pay local civil servants, who had been without wages for two or three months.
Kunming’s economic and debt situation
1. Kunming is the most economically powerful region in Yunnan Province, which has 16 prefecture-level administrative regions.
In 2022:
- Kunming’s GDP amounted to 754.1 billion yuan, or 26 percent of Yunnan’s total GDP. Qujing City, which ranked second in Yunnan in terms of economic growth, had a GDP (380.2 billion yuan) that was about half of Kunming’s. However, Kunming’s GDP growth rate of 3 percent was among the slowest in the province.
- Kunming’s general public budget revenue decreased 27 percent year-on-year to 50.525 billion yuan, reaching the lowest level in the past five years but accounting for more than 25 percent of Yunnan’s general public budget revenue. Kunming also had the highest financial self-sufficiency rate in the province at 58.53 percent and collected 39.414 billion yuan in tax revenue, which amounted to 78.01 percent of the city’s general public budget revenue and ranked first in the province.
- Kunming’s government fund revenue (mainly land sales) was 14.6 billion yuan, a sharp from about 95.6 billion yuan generated in 2019.
- Kunming’s balance of local government debt was 223.056 billion yuan, balance of interest-bearing debt of bond-issuing LGFVs was 374.249 billion yuan, and balance of municipal investment bonds was 76.335 billion yuan.
- Kunming’s debt-to-GDP ratio was 29.58 percent, debt ratio was 169.67 percent, and broad-caliber debt ratio was 454.33 percent (a moderately high level among provincial capitals in the country).
2. According to mainland media Yicai, 2023 is a peak period for the maturing of Kunming’s LGFV bonds, with 27.3 billion yuan worth of bonds due for repayment.
3. In the first four months of 2023:
- Kunming’s general public budget revenue increased 9.1 percent year-on-year to 20.68 billion yuan.
- Kunming’s government-managed fund budget revenue increased 1.3 percent from a year ago to 3.41 billion yuan. Of the total, 2.88 billion yuan (up 2.8 percent year-on-year) was revenue generated from the sale of state-owned land use rights.
Yunnan’s economic and debt situation
In 2022:
- Yunnan’s GDP ranked 18th in the country at 2.8954 trillion yuan. The province’s GDP growth rate of 4.3 percent was higher than the national average of 3 percent and ranked sixth in China. This placed Yunnan’s GDP growth rate in the middle to upper ranks among the provinces and GDP strength in the middle to lower reaches.
- Yunnan’s general public budget revenue increased 2 percent year-on-year to 194.932 billion yuan, ranking 20th in the country. Of the total, tax revenue accounted for 61.42 percent (119.719 billion yuan), or near the lower end among the provinces. Meanwhile, Yunnan’s general public budget expenditure was 669.974 billion yuan; financial self-sufficiency rate was 29.1 percent (ranking 24th in the country); and received 548.017 billion yuan of transfers from the central government, which mean that the province’s ability to spend was more dependant on central government subsidies.
- Government-managed funds generated 62.082 billion yuan in revenue, a decrease of 42.89 percent (mainly due to the sharp drop in land sales revenue) when compared to 2021. Also, the ratio of land sales fees to the general public budget revenue was 22.87 percent, or relatively low when compared with the rest of the country.
- The balance of local government debt in Yunnan Province was 1.20983 trillion yuan, a scale that places it among the middle to upper ranks of the most indebted provinces in China.
Our take
1. The “Minutes of a Meeting of Kunming City Investment Bond Experts” and other information circulating about Kunming’s debt issues look grim and suggest that the financial and debt problems of local governments in China are steadily worsening. The CCP regime is at real risk of seeing concentrated local government debt defaults as the Chinese economy continues to worsen and the central government is unable to bail them out through direct funding or facilitating the transfer of funds from wealthier areas to poorer areas.
2. The meeting minutes expose the Kunming authorities’ deployment of “countermeasures” to the central government’s policies (上有政策, 下有對策) as they strive to secure political “achievements” while covering up the risk of LGFV debt and financial risks. For example:
- The Kunming government’s shortage of funds is evident from their inability to pay civil servant salaries and service their debt. To obscure the situation, the Kunming government has been “robbing Peter to pay Paul” (拆東牆補西牆) by getting local LGFVs to take regulation-violating loans from the banks. The resulting increase in implicit debts and non-standard debts from such actions are basically technical defaults in disguise and serve to kick the can of debt risks a little further down the road.
- The extension and rollover of LGFV bank loans, as well as the banks not considering them to be non-performing loans, essentially covers up huge debt risks and systemic financial risks. The situation in Kunming is likely repeated elsewhere; the present scale of municipal investment bonds in China is as high as 13 trillion yuan, and local governments will have to make illegal bank loans and continually extend those loans (Zunyi Road and Bridge Construction Group rolled over 15.594 billion yuan worth of bank loans for 20 years in December 2022) to avoid officially defaulting on loans and being unable to secure funding in the future. Also, the financial risks borne by banks are likely to be significantly higher than what can be glimpsed from publicly available data and other information.
- The Kunming authorities and other local governments are worsening their debt risks by issuing special government bonds to pay off old debts instead of investing the funds in actual projects.
- The scale of interest-bearing debt issued by LGFVs is already substantial; a report issued by Tianfeng Securities on May 6 estimates the amount to exceed 70 trillion yuan in 2022.
- The Kunming authorities are essentially engaging in a form of debt monetization by getting local LGFVs to purchase land so that the local government can “generate” revenue.
3. The seriousness of Kunming’s financial and debt woes as hinted at in the meeting minutes bodes ill for the other cities and regions in Yunnan Province. Kunming is the capital of Yunnan and is the strongest region economically in the province. Relatively speaking, this means that other parts of Yunnan could be doing far worse than Kunming if similar practices are being carried out in those regions.
Meanwhile, Yunnan’s debt scale is only at the middle to upper regions in comparison to other provinces and is not the worst in the regime. Provinces with a higher debt scale than Yunnan and are economically weak could be experiencing more severe debt troubles.
4. The central government has long relied on a few economically developed provinces and cities to support the more economically backward regions through fund transfers. The meeting minutes, however, indicate that Shanghai suffered badly from its strict “zero-COVID” lockdown in 2022 and cannot afford to assist Kunming. In extrapolation, the three years of “zero-COVID” had likely seriously crippled the Chinese economy on the whole and hampered the ability of local governments to bring in revenue.
5. The meeting minutes suggest that the decline in Kunming’s local government revenue is closely related to the sharp drop in revenue from land sales. This is in line with pessimistic trends in China’s real estate sector and the lack of demand in general. A prolonged property sector crisis will bring home prices down, which would in turn aggravate the LGFV debt crisis as the value of their real estate collateral falls and securing funding becomes even more difficult.
6. We believe that continued deterioration of China’s economy in the second half of the year and further shortages in local government finances will worsen the debt and financial crisis plaguing LGFVs. As pressures grow, LGFVs and local governments will increasingly struggle to cover up the debt situation, resulting in a concentration of defaults and technical defaults.
With local governments struggling to sustain grassroots operations and maintain stability, Beijing will find it increasingly harder to deal with the internal and external crises plaguing the regime.
2 CCP skeptical of Western ‘de-risking’ as Sino-US engagements resume
CCP not convinced by ‘de-risking’
May 25
State mouthpiece Xinhua published a commentary titled, “Concocting ‘De-risking’ Towards China is Old Wine in New Bottles for the ‘Decoupling Theory’ — Part One in a Series of Commentaries on the US Discrediting China” (炮製對華“去風險”是“脫鉤論”新瓶舊酒——起底美國抹黑中國話術系列評論之一).
The commentary argued that the G7 “softening” its language from China “decoupling” to China “de-risking” is “not evolved thinking,” but a “repacking of old wine in new bottles,” with the same “small-yard, high-fence” (小院高牆) approach to impose a “technology blockade” around China. The commentary added that “de-risking” is still “decoupling and breaking [supply] chains” (脫鉤斷鍊) to “suppress and contain China,” and is a “more deceptive” way to “compel and coerce other countries into joining the ‘small circle’ to encircle China.”
The commentary later listed a series of items in answering its rhetorical question about whether the U.S. will “soften” its decoupling policy under the current situation, including claiming that National Security Advisor Jake Sullivan had called for a “more sophisticated decoupling” while profiting from China. The commentary then claimed that the South China Morning Post had said in a commentary that “the U.S. government hopes to avoid using the term ‘decoupling,’ but has not really changed its stance.”
The commentary also claimed that the U.S. had “forgotten that it is the biggest source of risk for the world economy.” In conclusion, the commentary said, “A bunch of political crooks has lied and spread rumors to the whole world, delaying the progress and development of mankind in the end.”
US, PRC trade and commerce officials meet
May 25
PRC commerce minister Wang Wentao arrived in Washington D.C. and met with his U.S. counterpart Gina Raimondo on the sidelines of the APEC trade minister’s summit.
According to a U.S. Department of Commerce readout, Raimondo and Wang had “candid and substantive discussions on issues relating to the U.S.-China commercial relationship, including the overall environment in both countries for trade and investment and areas for potential cooperation.” The statement added that Secretary Raimondo “raised concerns about the recent spate of PRC actions taken against U.S. companies operating in the PRC” and her commitment to build upon the engagement between President Joe Biden and Xi Jinping at the 2022 G20 summit in Bali.
The PRC commerce ministry’s readout of the meeting was similar to the U.S. version regarding the discussions, but added that the CCP regime has “major concerns about the United States’ economic and trade policy towards China, semiconductor policy, export controls, and foreign investment review.”
May 26
Wang Wentao met with United States Trade Representative Katherine Tai on the sidelines of the APEC trade minister’s summit.
The USTR’s readout of the meeting said that Ambassador Tai had shared her views on APEC progress and America’s priorities for the remainder of its APEC host year. She also spoke about “the importance of the U.S.-China trade relationship in the global economy and the need for both sides to continue engaging with one another.” Tai further spotlighted the “need to address the critical imbalances caused by China’s state-led, non-market approach to the economy and trade policy.”
A Xinhua readout of the meeting said that both sides carried out “candid, pragmatic, and in-depth exchanges on Sino-U.S. economic and trade relations, and regional and multilateral issues of common concern.” The readout added that the PRC side had raised concerns about the U.S. economic and trade policy towards China, Taiwan-related issues in the economic and trade field, the Indo-Pacific Economic Framework, and Section 301 tariffs.
Micron ban
May 21
The PRC authorities banned the use of Micron chips in key infrastructure projects. A Cyberspace Administration of China statement said that a review found that Micron’s products have “serious network security risks” which “pose significant security risks to China’s critical information infrastructure supply chain, affecting China’s national security.”
May 23
Senate Majority Leader Chuck Schumer said that the PRC’s effective ban on purchases of Micron chips “is not based in fact and is a troubling use of economic coercion against the U.S.”
Schumer added that he was “working closely with the Biden administration to make clear to the Chinese government that this sort of behavior is unacceptable and unproductive.” Also, “we are engaging with the broader business community as well as with our allies and partners to address the Chinese government’s restrictions against Micron.”
May 27
Secretary Gina Raimondo said at a news conference that the U.S. “firmly opposes” the PRC’s actions against Micron, which “target a single U.S. company without any basis in fact.”
Raimondo added, “We see it as plain and simple economic coercion and we won’t tolerate it, nor do we think it will be successful.”
PRC infrastructure hacking
May 24
Microsoft said in a report that it had uncovered “stealthy and targeted malicious activity focused on post-compromise credential access and network system discovery aimed at critical infrastructure organizations in the United States” being carried out by a state-sponsored PRC actor named “Volt Typhoon.”
Microsoft added that the Volt Typhoon campaign is “pursuing development of capabilities that could disrupt critical communications infrastructure between the United States and Asia region during future crises,” and that it has “targeted critical infrastructure organizations in Guam and elsewhere in the United States.”
The U.S. National Security Agency said that it is working with the Federal Bureau of Investigation and countries like Canada, New Zealand, Australia, and the UK (which together with the U.S. make up the “Five Eyes” intelligence-sharing community) to identify breaches.
May 25
In a press briefing, State Department spokesman Matthew Miller said that “the U.S. Intelligence Community assesses that China almost certainly is capable of launching cyberattacks that could disrupt critical infrastructure services within the United States, including against oil and gas pipelines and rail systems.”
May 26
When asked about the U.S. claims of the PRC targeting U.S. infrastructure with cyberattacks during a regular press briefing, PRC foreign ministry spokeswoman Mao Ning said that “all countries care about the security of their critical infrastructure” and made a jab at the U.S. in saying that “the perpetrators of the Nord Stream blasts have yet to be brought to justice.”
Responding to a question about the U.S. sending Stinger missiles to Taiwan on May 24 via presidential drawdown authority, Mao said that America’s provision of weapons to Taiwan “gravely violates the three China-US Joint Communiqués, especially the August 17 Communiqué, interferes in China’s internal affairs, harms China’s sovereignty and security interests, and undermines cross-strait peace and stability. This is extremely wrong and dangerous. China strongly deplores and firmly rejects this and has made serious démarches to the United States.”
European countries
In a May 26 report, The Wall Street Journal said that Beijing’s special envoy for Eurasian affairs Li Hui had been telling U.S. allies in Europe to “assert their autonomy and urge an immediate cease-fire” in Ukraine, leaving Russia in possession of the parts of Ukraine it presently occupies, citing Western officials familiar with talks. Li had also “urged European governments to view China as an economic alternative to Washington and said they should move quickly to end the conflict between Russia and Ukraine before it spreads.”
A diplomat interviewed by the Journal said Li was told that “it’s impossible to split Europe from America” and Europe will not pull its support from Ukraine. “We explained that freezing the conflict is not in the interest of the international community unless there is withdrawal of Russian troops,” a diplomat who spoke to Li said.
Another diplomat said that the PRC is “probably testing the unity of the West and trying to show initiative.”
Backdrop
The developments listed above follow the G7 summit in Hiroshima from May 19 to May 21 and President Biden saying that Sino-U.S. relations will “thaw very shortly” during a press conference after the summit.
Our take
1. The PRC’s propaganda about the G7’s “de-risking, not decoupling” approach to China indicates that it is reacting just as we anticipated in the May 25 newsletter. We wrote at the time that “Beijing likely firmly believes that ‘camp confrontation,’ decoupling, and efforts to ‘contain’ China are the status quo regardless of how the West repackages its statements, and will base its external policies on this assumption accordingly.”
Meanwhile, foreign ministry spokeswoman Mao Ning’s relatively moderate response to “sensitive” questions regarding the U.S. sending arms to Taiwan and concerns raised about a PRC state-sponsored group targeting U.S. infrastructure is in line with our assessment that the CCP could “make some practical policy adjustments or appear more ‘accommodating’ in negotiations (per its survival-dominance dynamic) to buy itself some breathing space.”
Beijing seems to be prioritizing domestic affairs at the moment and would have an interest in lowering Sino-U.S. tensions. A “thaw” in tensions would give the CCP opportunities to court much-needed foreign investments, implement measures to rescue the economy, and apply fixes to address local government financial and debt risks that are bubbling to the fore. Any “thaw” in the Sino-U.S. relationship, however, will likely only be temporary as Xi Jinping cannot properly assuage Western concerns about PRC ambitions since he is unable to make major compromises on external policies without suffering crippling blows to his “quan wei” (authority and prestige).
2. The brief readouts issued by the U.S. and the PRC following diplomatic engagements between Wang Wentao, Gina Raimondo, and Katherine Tai, as well as Raimondo’s statement on the PRC’s ban on Micron chips, suggest that efforts to “thaw” the Sino-U.S. relationship are currently lukewarm.
Concurrently, U.S. government warnings about the PRC targeting American infrastructure and capability of launching disruptive cyberattacks within the United States potentially lay the groundwork for Washington to later sharply escalate tensions with Beijing if needed. In early February 2023, the Biden administration made a big deal out of the PRC spy balloon incident before warning China later in the month against assisting Russia in the Ukraine war and helping Moscow evade the impact of sanctions.
As noted in the previous newsletter, the U.S. and its allies are firm that the Russia-Ukraine war should be resolved per their requirements and are not likely to tolerate a PRC-arranged ceasefire agreement that does not align with their stance. Continued attempts by Beijing to push for a peace plan that allows Russia to keep the territory it has seized could compel the U.S. and its allies to put off “engagement” and “suddenly” get tough on China, especially if the Russian-Ukraine conflict develops in a direction that jeopardizes Western interests.
3. With the PRC and the U.S. set on shoring up national security and preserving their respective national interests, the general direction of Sino-U.S. competition will not see significant changes over the long term even if there are “improvements” in the interim. The Sino-U.S. relationship could quickly become tense again as the domestic situation in both countries deteriorates and geopolitical dynamics evolve.