The recent crisis in China’s real estate market has put the concerns about social instability and the risk of a liquidity crisis in the financial system in the CCP’s face. So how will the CCP solve or at least mitigate the situation? The solution seems to be to pour money into real estate acquisitions. But where will this money come from?
To answer this question, first of all, we need to know that China has two “mysterious” public debt-raising instruments that are not on the official books, namely local government financial vehicles (LGFV) and special local government bonds.
The government directs LGFV to borrow heavily to buy real estate
Buying real estate is a relief for cities and provinces after private developers were rendered helpless by debt. Financing packages are helping many local authorities purchase large tracts of land.
LGFV are for local authorities to borrow money not listed on the balance sheets but are treated as a government debt to the financial markets.
According to a Financial Times article, many LGFVs, usually by local state-owned enterprises, are pouring in to buy large amounts of land with loans, rescuing provinces and cities struggling with cash.
Chinese local authorities have traditionally relied on LGFVs to support growth by spearheading infrastructure investment.
Now, LGFVs are being used to make money for the real estate sector, which accounts for about a third of total economic output. According to Pengyuan International, LGFV issuances increased by 184% at the end of April from a year earlier.
Money from land sales is an essential source of revenue for local authorities, which need it to pay off debts. But 85% of local authority debt is being held by commercial banks. If the regime fails to repay the debt, a crisis of default and liquidity in commercial banks will occur. Unfortunately, this private sector’s land purchases have dropped by a third since the CCP banned real estate speculation, similar to the situation in rural commercial banks in Henan.
Under political pressure from local authorities, LGFVs were forced to borrow more from state-owned commercial banks and issue bonds to finance transactions.
An executive at Yueyang Urban Construction and Investment Company, an LGFV issuer said, “We play an important role in keeping the land market and government revenue from falling off the cliff.”
According to the Financial Times, LGFV’s land acquisitions increased to $57 billion (400 billion yuan) in the first half of the year, up more than 70% from the same period in 2021.
An LGFV issuer in Hunan province spent nearly $183 million (1.3 billion yuan) buying land in the first half of this year. An executive from the Urban Development Investment Committee of Huancui District, Weihai province, said his LGFV paid at least double the market price for a suburban plot late last year.
“We invest for political reasons, not business reasons. State banks have provided financial resources for this land purchase,” said this executive.
Increase special bond debt to pour into infrastructure and real estate
Unlike any other global economy, Chinese law “invents” a Special Local Government Bond. According to Chinese law, local authorities do not have to record it to the national public debt.
Special bonds issued by locals are designed explicitly for infrastructure investment for the real estate market. When invested, infrastructure will change the “quality of commodities” of the real estate market and promote growth.
According to Moody’s, special local government bonds account for 73% of Chinese government bonds.
Unlike regular local authority bonds, the issuance of these special-purpose bonds only requires approval from the Standing Committee of the National People’s Congress (NPC).
This year, facing a severe economic slowdown and real estate slump, the CCP has issued $492 billion in special local authority bonds.
According to Chen Guohuang, deputy director of Guangdong Province’s Finance Department, nearly 80% of the special-purpose bonds issued this year have been in the transportation and industrial real estate sectors. For example, the Guangdong authority said it had issued special bonds worth $390 million to finance the construction of the Huangmaohai Trans-Marine Corridor project connecting the Greater Bay Area of Guangdong, Hong Kong, and Macau, according to SCMP.
A Goldman Sachs report said total local government bond debt rose from $2.25 trillion in 2013 to about $8.2 trillion at the end of last year. This amount is about 52% of GDP and is larger than the official government debt balance.
China’s local authority debt has always been a kind of “black box” with the central government and the People Bank of China (PBOC). The problem is the local authority is powerless to settle the debt because the primary source of income is selling land to pay the debt, which has almost disappeared because of slow transactions. Meanwhile, the cost of maintaining the “zero-COVID” policy is mercilessly eating away at the wallets of local authorities.
Local authorities across China are looking for ways to boost the real estate market, from encouraging farmers to put down deposits to buy houses with garlic and onions to encouraging civil servants to buy many houses. On August 16, a video went viral showing Deng Bibo, secretary of the Shimen District Party Committee of Changde City, Hunan province, speaking at the opening ceremony of “The Real Estate Trade and Exhibition Fair Real Estate in Shimen District 2022.”
He said, “I hope that at today’s meeting, comrades and all leaders, take the lead in buying a house, buy one and then buy two, buy two and then three, buy three and then buy four.” This statement of the local official goes against Xi Jinping’s policy, “Residential properties are not allowed to be speculated.” Nonetheless, if speculation temporarily can support the market, Chinese officials would not give up hope.
Collapse of the financial system can lead to regime collapse
Why should authorities from the central to local levels try to save the real estate market any way they can?
The reason is not only because of the size or contribution of real estate to the GDP, but its crash will lead to a massive amount of debt in the commercial banking system becoming bad debt. A potential debt crisis could disintegrate the financial system. Unlike democracies, in an authoritarian regime like Beijing, the financial system’s collapse can immediately lead to regime disintegration.
Since September 2021, a statistic from Goldman Sachs shows that the hidden debt of Chinese local authorities has increased by more than 50% compared to the country’s economy. But it is worth mentioning that commercial banks buy up to 85% of local authority bonds in China. Moreover, commercial banks in this system also invest in a part of the corporate bonds of domestic developers and LGFVs.
The real estate debt in the commercial banking system is not 25.7% of total outstanding loans as claimed by China. The real number can be up to 50 or even 70% of the total outstanding loans of the whole system or more. This is a concentrated risk, a considerable risk of cross-contamination from the real estate market to the commercial banking system.
This also means that the financial system will collapse as soon as the Chinese regime stops pouring in money into it, no matter how strong the political will of the regime tries to prevent this collapse.