As the troubled Chinese real estate behemoth Evergrande Group missed its deadline to make the first tranche of interest payments last week, concerns for the country’s local governments have increased. The local governments have been asked “to prepare” for the demise of the once loved company which featured in the coveted list of Fortune 500 and step in at the last moment.

The question now is: will these local governments which are already under a pile of debt, manage a bailout?

The overall debt level for these local governments is over a whopping $6trillion.

Even as the debt levels of these local governments rose steadily over the years, they escaped any major scrutiny. These local governments and their local government financing vehicles (LGFVs) have also been driving financing of the Belt and Road Initiative (BRI). LGFVs are financial arms set up by the local governments.

Also read: China’s real estate giant Evergrande misses payment deadline, headed for default

“China’s financing of projects including the BRI lacks transparency. All these years, they have managed to escape scrutiny but in the last one year, things have changed drastically especially amid the Covid 19 pandemic,” an analyst told India Narrative.

While there is no official data that the Chinese government has published on the overall debt levels of the LGFVs, several independent estimates suggest that their debt levels have reached alarming levels.

Infrastructure projects including those under the BRI umbrella need a long gestation period before they start yielding results. This has caused financial stress for many local governments.

“LGFVs flourished following the 2008 global financial crisis as a way of funding China’s infrastructure building spree, even if they did not generate returns,” a recent South China Morning Post report said.

As the pandemic severely hit the global economy, these vehicles have come under the spotlight.

In fact their ability to finance fresh infrastructure projects has diminished and to add to the problem, they have been taking new debts to service older ones.

Also read: Will China's rising debt problem hit its ambitious BRI projects?

The risk to the country’s banking system has also increased as more than 80 per cent of local government debt is held by commercial banks.

According to the report, former Ministry of Finance official Sun Xiaoxia told a forum in Beijing in June that the risk of default of a LGFV is high as “investments do not always produce a return, meaning local governments are not always able to support the LGFVs due to a fall in its own revenue.”

Role of local governments in the 2008-09 financial crisis

The Asian Development Bank pointed out that the Chinese local governments lack the ability to adjust rates (even within centrally specified bands), and thus do not have own-source revenues. This affects sustainable access to credit at local levels.

It is no secret that a chunk of China’s massive stimulus package of 4 trillion-yuan or $ 586.68 billion in 2008-09 — during the global financial meltdown– was financed by the local governments. Of course, the stimulus package helped the Chinese economy—China was the first major economy to emerge from the crisis. China posted an economic growth of 8.7 per cent and 10.4 per cent in 2009 and 2010 subsequently. In a more radical move, the government also officially endorsed the use of local government financial vehicles, an OECD report pointed out.

The local governments in China financed the stimulus plan mainly through bank loans in 2009, and resorted to non-bank debt financing after 2012 given the mounting rollover pressure from bank debt coming due, a manifestation of the stimulus loan-hangover effect, the Asian Development Bank noted.