For a while now we’ve been telling you about the work of professor Victor Shih who is warning about the $1trillion+ debts incurred by Chinese state governments.
A new report from research from Independent Strategy has a very nice characterization of these local governments, and their analogue to the US crisis: they’re the SIVs, the vehicles that allowed Citigroup (C) et. al. to mask the true state of their rot.
According to Shih, the rot is located in the so-called Local Government
Financing Vehicles (LGFVs) belonging to one of China’s many levels of
local government ranging from towns and counties to cities and provinces.
LGFVs are conduits, like the Special Investment Vehicles (SIVs) were
for western banks, used by local government to borrow and spend on
infrastructure and other projects (like real estate).
Local governments inject land banks, SOEs and cash into a LGFV to give
it assets and a capital base for borrowing. Guarantees of LGFV debt by
local governments are also common (as are guarantees of one LGFV’s
debts by another). The usefulness of the LGFV is that it allows local
government to borrow and spend way in excess of its own budget, where
normally tax revenues cover only about half expenditure (with the rest
coming from Beijing). Local government deficit spending is not allowed.
There are over 8,000 LGFVs in China with only paltry information avail-
able for all but 100 of them and even for those the information is incom-
plete. Local authorities have used LGFVs to divert funds borrowed for
authorised projects to other ends (e.g. loans for infrastructure spending
channeled into real estate speculation by local cadres) or to borrow and
feed back the proceeds to local government. LGFVs are predominantly
unprofitable, with the debt service on existing debts being funded by
further cash subsidies from local government and additional borrowings.
And they have been financed by asset injections at inflated prices (e.g.
local government land banks) to dress up their balance sheets and facili-
tate borrowing, despite often being insolvent.
It’s these SIVs that allow for this:
In conclusion, these local entities — which get at least half of their revenue from real estate, and not taxes — have one solution: keep praying for a bubble (oh, and hope that the export sector never slows down).
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