Global rating agencies S&P Global and Moody’s faced criticism during a hearing at the US House Oversight Committee on Wednesday, June 26, as their ratings failed to reflect the tens of trillions of dollars of “time bomb” risks brought to the global financial markets by the financing platforms of Chinese local governments (LGFV).
According to the South China Morning Post, during the hearing, Democratic Representative Katie Porter emphasized the challenges LGFV faces due to the downturn in the Chinese real estate market. These platform companies use land leases controlled by government departments as collateral, borrowing on behalf of provinces and cities to fund projects such as roads, ports, and other infrastructure. However, with the sharp decline in property prices in China, this poses risks.
Porter explained that when property values on leased land drop, it can be likened to the 2007-2008 global financial crisis, where the collapse of debt backed by subprime mortgages and other risky assets triggered a global financial crisis.
“Once these long-term urban leases expire (which will begin in the next five years), there will be an oversupply, and the leases won’t be as valuable. This will weaken the bond market,” she said, warning that if the Chinese economy collapses, it will have global implications.
Just how large is the debt market of Chinese LGFVs? Global investment management company Pimco estimated in 2023 that local government financing platforms had reached 55 trillion yuan (7.6 trillion US dollars) in debt in 2022, four times the 13.5 trillion yuan in 2012.
Porter’s in-depth analysis of the Chinese economy at the hearing earned praise from some witnesses. Eric Bethel, a former US representative at the World Bank, noted that many of these bonds are sold globally and internationally, calling it a “time bomb.”
He pointed out that China is facing a significant debt crisis, with the economy declining and a breakdown in the relationship between the government and the people.
Mary Kissel, an advisor to former US Secretary of State Mike Pompeo, also praised Porter’s analysis at the hearing, suggesting that Congress could take action to break the monopoly of Standard & Poor’s and Moody’s, requiring US investors to conduct due diligence themselves rather than outsourcing it to rating agencies.
Official data released by the Chinese government on June 17 showed that prices of new homes in 70 major cities (excluding state-subsidized housing) fell by 0.71% in May compared to April, the largest drop since October 2014. Current home prices have fallen by 1%, the largest decline since the data collection method began in 2011. Year-on-year, new home prices fell by 3.9% in May, compared to a 3.1% drop in April. The real estate development index in May was 92.01, continuing a downturn since November last year.
In May, sales of new homes by the top 100 developers in the country fell by 33.6% year-on-year.
These numbers indicate that despite Chinese efforts to support the housing market, the real estate industry still seems unable to find a bottom. Chinese real estate giants are facing liquidation issues due to debt crises. Evergrande Group was ordered to liquidate by a Hong Kong court in January; Jiayuan Group obtained a seven-week reprieve from the Hong Kong court this week to finalize a debt restructuring plan. The court postponed the hearing for Jiayuan’s liquidation petition to August 12 on June 24. Shimao Group is also facing a liquidation hearing due to debt problems.
With a sharp decrease in major land sale revenue, local governments are having fewer options to raise new funds, intensifying concerns about LGFV’s ability to fulfill debt obligations and its broader impact on the banking industry and market.
A report by Reuters in March 2023 cited three sources saying that some Chinese banks with exposed risks to LGFVs are receiving more requests from LGFVs to extend the maturity of their expiring debts by six months and lower interest rates.
The deterioration of LGFV prospects has also made some shadow banks wary of the risks associated with these entities and reluctant to provide new loans.