Faith under challenge: LGFVs’ diverging path
Sluggish property market and stressed fiscal revenue
In China, the property sector directly contributed around one-third of national fiscal revenue. “Land finance”, referring to government budgetary income generated from concessions of state-owned land-use rights and taxes related to real estate, and land-related funding, best captures the source of revenue of China’s local and regional governments (LRGs). A booming property market is the premise of land finance, and the current setback in housing and the land market has challenged the sustainability of land finance more than ever. Government fund revenue dipped for the first time in seven years in 2022, mainly due to the continued decline in land transactions as a result of less land acquisition by real estate companies.
LGFVs and land funding
LGFVs emerged alongside China's accelerated urbanisation, as a solution for LRGs to meet infrastructure development needs. Given the shortfall in tax income and funding constraints, LRGs had recourse to land finance and began to set up local financing platforms, i.e., LGFVs, to raise funds and undertake infrastructure projects on their behalf. Many local governments injected substantial amounts of land into LGFVs to enhance the collateral available to them. With implicit credit endorsement from governments (even guarantees in the past) and land as collateral, the platform companies were favoured by financial institutions. Funding was obtained to meet capex on infrastructure, and increased urban construction raised land values. This method of land funding enabled LGFVs to accumulate and roll over debt with limited operating cash inflow.
Faith in LGFVs floundering?
LGFVs will likely remain instrumental in public projects, despite the evolving LRG-LGFV relationship and LGFVs’ changing business model. LRGs still need LGFVs to fulfil policy mandates and are, thus, willing to support subordinate investment platforms. However, LRGs’ ability to provide such support depends on their fiscal strength and the availability of local public resources, including local SOEs, and financial resources from local institutions, especially state-owned banks; this differentiates the credit performance among LGFVs.
While LRGs’ ability to support varies, so does credit performance among entities from the same region. LRGs are likely to allocate their depletable resources to subordinate LGFVs according to the platforms’ importance to local governments; this is decided by the administrative level of owner governments and the number and political implication of public projects undertaken by each LGFV.
LGFVs and LRGs have been tenacious in repaying public debt, and servicing public debt has come at the cost of rising credit risk for non-public products. Troubled platforms would allocate financial resources primarily to public bonds and leave non-standard products at greater risk. As weak LGFVs found it difficult to find funding through the public market, their reliance on non-standard products increased. The time lag between the emergence of non-standard-product credit events and potential market reaction leaves decent room for investors to adjust their portfolios.
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