Low-hanging fruit and a mountain of debt – how China’s credit binge is playing out

CHANGDE, China — When Mr Ma Heshui set up a vineyard in central Hunan province with a friend four years ago, they were surrounded by farmland.

They leased 1.6 hectares (four acres) in a quiet spot on Changde’s northernmost edge, 3km from its main train station. But as their grapevines developed, so did the city of 6 million – and they watched as a brand new urban centre sprang up around them.

Now, the vineyard sits at the centre of a “new town” covering an area of 27 sq km. A 3.3 billion yuan (S$658.4 million) hospital has just opened there, an imposing city hall will follow, and on a recent visit by the South China Morning Post, workers were installing curtain walls on two high-rise buildings that will be the headquarters of the city government’s biggest fundraising vehicle, Changde Caixin Financial Holding Group.

“This is totally beyond my imagination – the whole area developed very quickly after several new main roads were built,” said Mr Ma, a 44-year-old father of two. “But construction of many government projects has really slowed down recently. It seems they’re suddenly running out of money.”

Changde is not the only city where building work is slowing after an infrastructure spending spree driven by local authorities seeking fast development, paid for with easy credit from the state banking system.

Government-led spending on roads, bridges, airports, railways, residential towers, conference centres and sports facilities has helped to propel China’s growth in the last decade, but it has left Beijing with a mountain of debt to deal with. The Bank for International Settlements put total debt at 256 per cent of China’s gross domestic product in mid-2017 – much of it racked up by state-owned enterprises and local governments.

President Xi Jinping wants the overall debt level in the economy reduced to keep a lid on financial risk, a process that will be painful – and potentially disastrous – for places like Changde, where many projects will not get finished without continued funding support.


Changde – known as “China’s Stalingrad” for its resistance against the Japanese in a 1943 battle – wants to become a regional economic centre alongside provincial capital Changsha, which is two hours away by train.

It is one of hundreds, if not thousands, of Chinese cities trying to take a bigger place in the country’s economic landscape. But like many others, its ambitious development blueprints and countless infrastructure projects go well beyond what the government can afford. Changde’s fiscal income of 16 billion yuan last year covered just a quarter of its spending – the rest came from Beijing and Changsha.

So when Beijing tightened control of the public-private partnerships that are used to channel private funds into infrastructure, and the banks became less willing to lend money to projects that would not immediately be profitable, Changde was one of the places that felt the impact.

At least seven of the city’s key projects due to get under way this year had yet to break ground by June, according to a government document. They include a huge convention centre and “conference town” covering 60 hectares, a plan for 27 roads, eight bridges and 26 bus stops in the north of the city where Mr Ma’s vineyard is located, another plan for 50 roads and five bridges in the west, and a stadium.

Dozens of other projects – including three shanty town redevelopments – are behind schedule, according to the document released by the city’s planning agency, the Changde Development and Reform Commission, last month. It said the delays had been caused by the “government debt clean-up and policies restricting fiscal spending and forms of investment”.

The mid-sized city made headlines in June when a memo from a meeting between government officials and local bank branches was leaked. According to the memo dated June 22, the Changde officials asked the banks to roll over all loans to financing vehicles to the local government and its affiliated vehicles from July, and to lower their interest rate to the benchmark of 4.35 per cent a year.

Changde’s municipal finance office issued a statement saying the report on the memo “was not in line with the facts” and the city did not have “specific policies” to deal with local government debt. It added that the “local economy is functioning normally and the risks from debt are under control”.

A local private equity professional who is involved in raising money to fund government projects said “Changde did nothing different from hundreds of other Chinese cities” through its borrowing.

“The financing vehicles did a pretty good job of shoring up the local economy, improving urban infrastructure and controlling debt,” said the person, who declined to be named.

Changde had outstanding debt of 34.6 billion yuan and another 3.5 billion yuan of contingency liabilities at the end of 2016, according to official figures.

The debt of its financing platforms – which could potentially become the government’s responsibility – was 84.2 billion yuan. That would mean the city’s combined debt was only about a third of its GDP, which grew 8.4 per cent to 323.8 billion yuan last year.

But the lack of transparency around official figures given by local governments is also part of the debt problem. Beijing says the situation is under control, based on the latest National Audit Office survey that put local government debt at 15.4 trillion yuan, with another 8.6 trillion yuan of contingent liabilities at the end of 2014.

Many economists and institutions, both Chinese and international, disagree, saying it could be much worse because government borrowing is often disguised using financing vehicles and state-owned enterprises. Such concerns prompted rating agencies Moody’s and S&P to lower China’s sovereign credit rating last year for the first time in nearly three decades.

Outspoken Chinese lawmaker Yin Zhongqing told the Post that implicit local government debt ballooned to at least 20 trillion yuan in the past three years, based on bank data and internal sources.

According to Yan Yan, chairman of China Chengxin International Credit Rating, total local government debt could be as high as 50 trillion yuan if financing vehicle borrowings, the government part of public-private partnership projects and lending arranged through policy banks is included. That would be more than three times the official figure.

In Changde, it was clear by April that the authorities were under huge pressure to start repaying debts. City officials called a meeting of more than 30 financial institutions, telling them the government guarantee for local financing vehicles would be withdrawn in line with Beijing’s orders.

One banker who was in the room said it was not taken seriously by the lenders at the time because that “tacit guarantee” had always been there and all local governments were part of the centralised apparatus, backed by Beijing.

But the banks have become worried since it became apparent that the central government may let some local vehicles go bust.

At the provincial level, Hunan governor Xu Dazhe said six financing vehicles would be kept, while every city could have four, and counties could have two at the most. Changde has at least seven local government financing vehicles.

“Some of them will eventually go bankrupt if the government refuses to step in – no one wants to be the first,” the banker said.

One of the first to start offloading assets is Changde Economic Development and Investment Group, which has instructed agents to sell properties including stores at two tourism sites – Hejie, or River Street, and “Little Hanover”, a new area inspired by the German city.


Changde is just one city where debt has spiralled, and nationwide it is a product of China’s centralised authoritarian system.

Mr Zhang Lin, a researcher with Beijing-based independent think tank the Unirule Institute of Economics, said local government officials tended to borrow as much as they could because they knew that, ultimately, Beijing would bail them out.

“Suppose you are the provincial governor – the most obvious indication of how your subordinates, like mayors, are doing is how many skyscrapers there are downtown, and how fast the economy is growing,” he said. “Historically, budget restraint has never worked.”

Local government spending financed by debt is also the nexus of China’s investment-driven model. Beijing has responded to changes in external demand with infrastructure spending, often through local governments, to keep growth on track. China’s growth “slowed” to 6.7 per cent in the second quarter this year.

As its trade war with Washington escalates, Beijing has eased off on debt control to give the economy a push. The State Council on July 23 said it would increase bond issuances to 1.3 trillion yuan to support infrastructure investment. The cabinet also encouraged bank lending to financing vehicles under “market rules” to ensure continuity of construction projects.

That could inspire a fresh round of spending in the coming months, including in Changde, meaning stalled projects – like its section of a high-speed railway line that is waiting for approval – might get moving again.

But for vineyard owner Mr Ma, project delays are not necessarily a bad thing. If the government goes ahead with plans for his area, his grapevines will be sacrificed to make way for a petrol station.

The developer would pay the government 2.5 million yuan per mu (0.0667 hectares), he said. But Ma and his friend, who have a nine-year lease, will receive just 30,000 yuan per mu. With construction delayed though, Ma can continue running his vineyard and reap the returns.

He is ambivalent about all the changes, saying he was also proud to see his hometown developing so fast.

“The urban planning, construction and overall landscape of Changde has been lifted significantly and it is so much more liveable here now,” Ma said. “To be honest, few [of the neighbouring] cities will be able to catch up with us.” SOUTH CHINA MORNING POST