If the Chinese government can achieve its economic growth target of 5.5% this year, it will be thanks in part to retail investors like Jane Song.
In May, Song invested 200,000 yuan ($29,600) in a fixed-income wealth management product issued by a local government financing in the eastern province of Shandong. A financial adviser in Shanghai, she is unfazed by the growing reluctance of larger investors to support LGFVs, which play a vital role in financing China’s infrastructure development.
“If WMP defaults, the local government will have problems accessing credit in the future,” said Song, who expects to receive 8.8 percent interest on the “medium-risk” product. “They’re not going to let that happen.”
The scale of the challenge China faces in meeting its annual growth target was underlined on Friday by data showing the economy expanded just 0.4% year-on-year in the three months to June.
Achieving 5.5 percent growth for the year will only be possible if LGFVs accelerate construction activity. But local government instruments have struggled to borrow from banks and institutional bond investors and are increasingly forced to offer retail investors high interest rates to raise cash.
The direct entry of retail investors, some for as little as Rmb50,000 each, is a new direction for LGFV. They traditionally raise capital from institutions — mainly banks — or from wealthy individual investors acting through third parties such as trust firms and brokerage companies, and with minimum investments set at Rmb1 million.
But Beijing’s crackdown on shadow banking in recent years has made access to such individual investments more difficult. The outstanding value of infrastructure-backed trust products has almost halved from its 2017 peak of Rmb3.2 trillion.
Last month, Limin Construction Development Group, an LGFV in Shandong’s Zoucheng city, turned to social media platforms such as WeChat in its efforts to raise Rmb200 million from retail investors.
It promises an interest rate of 8.6 percent – far more than it would pay if banks were willing to lend. The average annual interest rate charged by Chinese banks for business loans was 4.16% in June.
Limin’s prospectus did not specify how the proceeds would be spent, other than to say they would help “replenish working capital”.
“You don’t need to know exactly how we’re going to spend the money,” said a Limin executive. “We’ll get you back in time and that’s all that matters.”
The executive, who requested anonymity because he is not authorized to speak to foreign media, added that the car is close to reaching its fundraising goal.
Similar calls have been made on social media by hundreds of LGFVs across the country, raising fears that already heavily indebted local authorities are building up potentially explosive debt loads.
“It’s another way to [local governments] to delay the inevitable,” said Andrew Collier, managing director of Orient Capital Research in Hong Kong. “This is the last gasp of a desperate economy trying to pack in its growth.”
Samuel Kwok, head of Asia-Pacific public finance at Fitch Ratings, said the issuance of high-cost short-term debt by many LGFVs in China’s economically weaker regions is a sign that they are having trouble refinancing.
“The ability to refinance is key for LGFVs as they need to finance local economic development on behalf of governments,” said Kwok.
Bond investors and other more traditional lenders have become more wary of LGFVs, even as Beijing makes supporting infrastructure projects and stimulating an economy hit hard by President Xi Jinping’s “zero COVID” lockdowns a political priority.
LGFVs with credit ratings of AA or below raised just Rmb204 billion from the bond market in the first half of this year, down 50% from the same period in 2021, according to East Money Information, a financial data provider.
A number of local banks, which are China’s biggest bond buyers, told the Financial Times they were shunning low-rated LGFV bonds. “We will not use LGFV bonds rated below AA+,” said an investment manager at a lender in the eastern city of Suzhou. “And there is a clear preference for bonds issued by economically strong regions.”
Limin, a Zoucheng-based LGFV, reported Rmb2.9 billion in cash at the end of last year, almost 80 percent of which it could not access because it was pledged as a margin deposit for bank lenders.
“If you have 2.9 billion yuan worth of cash and you’re rushing to pay 9 percent on 200 million yuan in private loans, it’s about pretending you’re solvent when you’re not,” said Orient Capital’s Collier.
Limin said it was “working normally”.
Yang Xiaoyi, a government finance analyst at Beijing-based consultancy Mingshu Data Technology, said it was increasingly common for LGFVs to delay paying the principal they owed to investors while they paid the annual interest due – essentially turning their investments into perpetual bonds.
“You have to let the investment roll over indefinitely to avoid default,” Yang said.
Regional authorities are aware of the risks. In an internal circular issued last month by the Henan Provincial Finance Bureau and seen by the FT, the regulator said it would ban local LGFVs from selling debt securities directly to individuals. The ban came after hundreds of investors invested in multiple platforms offering annual returns of 8.5 to 10 percent.
“The practice,” the bureau said, “seriously disrupted economic and financial order and could easily lead to social instability.”
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