China is very much hoping its economic fall will end with a soft landing. For Beijing, that’s meant pumping money into old industries to keep growth rates from collapsing all at once. Downstream, that’s meant local governments and bureaucrats under performance pressure to do anything they can to boost GDP, like building more houses than China has people. Yet, stimulus at that scale has costs. And, even with Beijing providing round after round of credit assistance, local governments are so hungry they’re increasingly looking outside the country for help shouldering their debt burdens. Bloomberg’s Christopher Langner reports:
Debt from special-purpose vehicles linked to municipal and provincial governments — leverage that central authorities are trying (unsuccessfully) to extinguish — is becoming more common in overseas markets. What’s worse, lately it’s been the weakest cities and provinces panhandling to international investors.
Since June, as many as six local government financing vehicles have sold dollar bonds, bringing the total issued by such entities to at least $4 billion this year, just shy of the record $4.1 billion logged in all of 2015. Three offerings were scored below investment grade by Fitch, whereas prior to 2016, only one junk security of its kind had surfaced internationally.
Langner is being a bit too generous; Beijing has played a significant role birthing the debt monster. Moreover, reforms have more often originated from the bottom-up than the top-down, despite incentives for local officials to do otherwise.
Perhaps most concerning is how systemic dysfunction has made these special-purpose vehicles even more toxic. In order to attract foreign buyers with a yuan devaluation looming, local governments have had to price their debt in dollars. Yet Beijing, increasingly running out of levers to pull, is eyeing yuan devaluation as an easy way out when signs of economic trouble pop up between waves of stimulus. That might make some sense as Beijing tries to boost exports, but it will be a big problem for local governments as they struggle to pay interest on their debt at less favorable exchange rates.
With prospects for these bonds so dim, you would think money managers in Singapore and New York would stay away. However, living in a world of low returns and negative interest rates, investment opportunity is scarce and the promised 5% returns may be too seductive to resist. Many in the banking sector are ringing the bell on Chinese financial risk, but individual traders are desperate.
The Chinese slowdown is already a major burden on the world economy, and there was already reason to be concerned about the second- and third-order repercussions that local Chinese debt swirling around their shadow banks could have. So far, American institutions have been less exposed to China than pretty much anywhere else—and that’s a huge advantage for the U.S. It’s hard to imagine that basic fact changing any time soon, but it’s nonetheless worth keeping an eye on whether investors start getting their hands dirty in their search for better returns.
China has inarguably gone through some miraculous transformations in recent decades. Yet, it has also done so in some unbalanced and unwieldy ways that are leaving the rest of the world scrambling to contain the risks and fallout. And it continues to require more heavy lifting than expected to contain it all; whether its with industrial overcapacity or the South China Sea. The leakage of bad bubble debt out of the mainland only means there’s another hole to plug in a ship that is looking quite leaky indeed.