China’s urban investment companies are facing record-high default rates on their non-standard debts, with analysts estimating the overall default scale to be as high as $800 billion (around 5.7 trillion Chinese yuan). This situation could lead to many individual investors falling into distress and highlights the escalating bad debt issues of local government financing vehicles (LGFVs).
Last year, faced with a wave of bad debts in the municipal sector, the central government of the Chinese Communist Party took action by allowing local governments to borrow new money to repay old debts. By issuing new bonds, local governments raised about 2.2 trillion Chinese yuan (approximately $309 billion). At the same time, the CCP also ordered state-owned banks to provide additional support.
These measures pushed borrowing costs to historic lows, leading investors to re-enter the market eagerly purchasing bond-related products. Investors believed that these bond products had implicit guarantees from the country.
However, one aspect that remained unresolved was the so-called “non-standard debt financing.”
Urban investment bonds can be divided into standard bonds and non-standard debt financing. The latter is mainly in the form of wealth management products issued on local financial exchanges, such as asset management plans, targeted financing plans, convertible bonds, or revenue rights products, with individual investors being the main participants.
Bloomberg pointed out that the default rate of China’s urban investment companies’ “non-standard” products has surged to a historic high. While the official figures are not available, analysts estimate it to be around $800 billion.
Take Lulu Fang, for example. The 60-year-old Lulu Fang runs a small trading company and incurred losses of 15 million Chinese yuan by investing in Guizhou political trust products.
She had hoped to earn a stable return of about 8% on these investments, which was perceived as better than earning interest in a bank account. However, after the products defaulted last year, her lifelong savings turned into nothing.
“My life now is a mess,” she told Bloomberg. “I’ve worked all my life, and all my retirement money was put into these. I was told they were safe. It’s a lie.”
Various provinces, cities, and towns in China often use “urban investment bonds” (LGFVs) to fund infrastructure projects, including roads and ports. However, the projects funded by urban investment bonds may not necessarily be profitable, forcing them to rely on government support.
According to data from Financial China Information & Technology, in the first nine months of this year, there have been 60 non-standard products linked to urban investment bonds that have defaulted or shown repayment risks, a 20% increase compared to the previous year. This number is at the highest level since 2019.
As the issuers or trustees of “non-standard” products typically do not disclose details like default amounts, the total amount for 20 known-sized products is 4.55 billion Chinese yuan.
Laura Li, Managing Director of S&P Global Ratings, stated that despite the CCP introducing a series of policies to address the issues with urban investment bonds, there is no guarantee for the repayment of LGFV debts. If defaults occur, it could endanger financial and social stability since it is part of the capital market.
Although there are reports that the central government of the CCP is considering allowing local governments to issue up to 6 trillion Chinese yuan in bonds before 2027 to refinance debts off the balance sheet, some analysts doubt whether this will happen.
Even if the CCP allows for new borrowing to repay old debts, local governments are likely to prioritize repaying standard bonds.
The experience of individual investors indicates that the chances of recovering money once non-standard products default are not high.
Five years ago, Jason Lai invested 3 million Chinese yuan in an LGFV product in the Anshun area of Guizhou but the product eventually defaulted. Jason, an employee of a state-owned enterprise in Beijing, made four trips to Anshun seeking repayment.
“Since the first default in 2019, I have barely recovered less than 10% of my principal,” Jason told Bloomberg. “I will never buy these types of products again.”