Local governments have over-borrowed and are having cash flow problems. Beijing has allowed them to raise new money, via bonds (which previously were banned). This will help with short term cash flow issues, and buy time to get their borrowing in order.
But the trend is that the situation is worsening. Much of the local government investment is thought to have gone into the (overheated) real estate sector. And a severe downturn would have a compounding negative effect.
China may be heading towards its own credit crunch.
In 1994 Beijing banned local governments from selling bonds or running budget deficits, because of concerns that they were running up huge debts they could not repay.
The local governments got around this by setting up special companies which would raise loans or other financing for public works and investments.
“There is huge concern among policymakers that much of this borrowing was spent on wasteful and uneconomic projects and that local governments will struggle to repay many of these loans.”
Beijing has now decided to allow local governments to issue bonds.
The intention is to “meet cash shortfalls and start the process of cleaning up the… special purpose investment vehicles.”
Whether they will be able to do this is unclear. But the slowing growth of China, and the economic situation in the rest of the world is making this more difficult rather than easier.
Kohlberg Kravis Roberts is expanding into hong Kong and setting up a unit to profit from faltering and over-indebted companies. “There will be opportunities in China, especially in the property company sector.”
The move is part of increased interest in distressed-debt investors in China.