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A local government financing vehicle in Zunyi, Guizhou officially became the first LGFV in China to restructure all of its bank loans last week. This is a big deal since it's a precedent for how other off-balance sheet debts may be restructured. A🧵 1/ finance.caixin.com/2023-01-03/101984942.html?channel=1022
LGFV debts or local government “hidden debts” are a big problem. For @asr_london I estimated that their off-balance sheet debts and contingent liabilities rose to CNY47tn (39% of GDP) in September, up from CNY20tn (27% of GDP) at the end of 2016. 2/ 
Regulators have been trying to curb LGFV debts since at least 2010. Lately they’ve made some progress, maybe. Guangdong said it eliminated all its hidden debts in January, and Shanghai and Beijing are aiming to do the same. 3/
But the hidden debts of poorer provinces are proving harder to resolve, and so the State Council seems increasingly willing to use the bankruptcy process. It first floated the idea in April last year. 4/ www.gov.cn/zhengce/content/2021-04/13/content_5599346.htm
But why Guizhou province? For one, it leaned heavily into the credit & investment-intensive growth model of the 2010s. In 2010-19, Guizhou’s annual loan growth exceeded the national total and its neighbours’ by more than 5 percentage points. 5/ 
Its transport chief said every CNY100mn invested in highways would generate CNY400mn in GDP. It did generate GDP in the short run. But building highways in mountains is costly, and traffic is low. So tolls couldn’t pay the projects’ interest. 6/ www.chinafile.com/multimedia/infographics/chinas-new-roads-are-taking-toll
These problems caught up with Guizhou, and the State Council gave it special permission to restructure its LGFV debts in January last year. (See paragraph 29 here - www.gov.cn/zhengce/content/2022-01/26/content_5670527.htm) 7/
Why Zunyi city? Well, it leaned even more heavily into this debt-intensive growth model than the rest of Guizhou province. It was known as one of the “four kings of urban investment” (城投四大天王) in the bond market. 8/ finance.sina.com.cn/chanjing/gsnews/2022-09-22/doc-imqqsmrp0047499.shtml
Zunyi’s LGFVs began defaulting on trust loans and other non-standard debts at the end of 2021, which triggered a bunch of guarantee clauses for other LGFVs. It was a mess until the city set up a working group to restructure the debts. 9/
Setting up the working group was in line with the State Council’s emergency plans for local debts as outlined in 2016. This also implies that Zunyi Daoqiao will not be the LGFV in Zunyi to have its loans restructured. 10/ www.gov.cn/zhengce/content/2016-11/14/content_5132244.htm
For @asr_london, I drew four lessons from this. (Note that the terms of the restructuring first began to tickle out in July, and I wrote about it in November. All of the above is also pulled from that note.) 11/
First, although all of Guizhou province was given special permission to restructure its debts, only one city has so far. This suggests the default risk mainly sits at the city or prefecture level, making it more difficult for analysts to know where problems may arise. 12/
Second, LGFV balance sheets are tied up in a complicated net of crossholdings and debt guarantees. Restructuring one LGFV’s debts in isolation may not be possible. So other cities may follow Zunyi’s lead and set up a group to negotiate a restructuring their hidden debts. 13/
Third, only trust and bank loans were restructured, not Zunyi’s LGFV bonds. Policymakers seem to think the restructuring of hidden debts should be hidden, too. But this may not be tenable in the longer run. 14/
Zunyi’s LGFVs still have little hope of ever repaying the principle on their debts. It’ll only pay interest on the restructured loans for 10 years, then start paying the principle down over the next 10, by when it’ll be someone else’s problem. 15/
Finally, the political consequences for this seem to be small, at least at the elite level. 2 Zunyi officials were arrested for corruption, but Chen Min’er, who drove Guizhou’s debt binge, first as governor then as party secretary, has since been elevated to the Politburo. 16/
But Guizhou’s problems may just be starting. Tighter regulations for on-balance sheet bond issuance mean that its ability to raise funds via muni bonds has been curtailed. 17/ 
The original justification for muni bonds was that “opening the front door” (on-balance sheet bonds) would allow “regulators to close the backdoor” of LGFV debts. The latter didn’t happen. Now both doors are closing for Guizhou. 18/
Finally, there’s some evidence that LGFV risks can spillover to the muni market. This is actually good, since it demonstrates that China’s capital markets are becoming more efficient, at least at the margin. 19/
This chart compares the yield on a muni bond issued by Guizhou in 2017 to similar bonds issued by its neighbours. Squint, and you can see a spike in Guizhou’s spreads following the Zunyi trust default in 2021, which reversed once the restructuring group was set up in June. 20/ 
My bottom line is that a large share of China’s sub-provincial level governments are in severe financial distress. Guizhou’s LGFV debt restructurings are likely only the tip of the iceberg. This likely to be a bigger problem in 2023. /end
