Payback time

Debt as far as the eye can see...

The road ahead is far from clear for Yunnan Highway Investment and Development Company. With no obvious income flow, it’s not apparent how the company will repay the whopping Rmb90 billion ($14 billion) it owes to a range of banks.

It all came to a head in April, when the company told its lenders that it would only pay the interest on its loan, not the principal, reports Century Weekly. That had the company’s banks desperately looking for a solution that would avoid having to write down the debt as a bad one. One possibility is that the local government will inject more capital into the company, thus allowing it to repay its loans as expected. Another idea is to restructure the debt into a more customary company loan, which would then be rolled over. Both seem to be postponing the inevitable.

The recently-revealed case is a landmark of sorts: the first occasion that a local government financing vehicle has ‘defaulted’ on its bank loans.

Expect plenty of similar stories across the country, and even in the capital itself. As 21CN Business Herald reports, the municipality of Beijing doesn’t just have an issue with its local financing vehicles. It is also facing a potential crisis over land reserve loans (money borrowed to compensate residents for land that the government intends to sell to developers). Since the launch of the national stimulus package in 2008, the capital city has accumulated Rmb200 billion worth of land reserve loans, which require interest payments of Rmb10 billion annually, reports 21CN.

Won’t the land sales themselves make it easier to pay off the loans? They might if all districts in Beijing were equal. In Chaoyang, home to the main business district, it’s pretty easy to offload land to developers. But in other parts of the city, the task is much more of a challenge. On June 15 three suburban plots went up for auction: one in Fangshan had no takers, two others in Tongzhou received lowball bids from developers.

The land reserve loans usually have a two year maturity. But as it looks as though many Beijing district governments will be unable to cough up the cash, borrowers and lenders are again looking for ways to prevent the debt going bad.

In recent months, the issue of local debt has been a popular topic for China bears who argue that excessive borrowing after the government stimulus has become a debt time bomb (see WiC110 for a Talking Point on the topic, and another article last week covering HSBC’s latest research on the problem).

Some now think that a financial implosion could be imminent: “No land finance, no new Beijing. No mortgage on land, no huge local loans,” financial commentator Ye Tan told National Business Daily. “Beijing’s land financing model is close to bankruptcy. China’s radical model of economic development with real estate as the main collateral for urbanisation will come to an end.”

Certainly, local government debt is hard to ignore: a report by the National Audit Office released this week puts the national total at Rmb10.7 trillion, representing 27% of GDP; and banks have the most to lose, since they have stumped up 80% of the capital.

The property market is the key to understanding much of the potential for financial default, with the National Audit Office forecasting that as much as 40% of local government debt repayment will depend on the ability to sell land.

But here’s the rub: the central government has been trying to engineer a slowdown in runaway price increases in many cities, a move that could end up leaving the municipal authorities with a major budgetary shortfall.

The capital city is a case in point. Beijing saw some of the biggest pick-up in real estate prices until recently. But it has since been deluged with administrative measures designed to take much of the steam out of the market. This then has a knock-on effect by hitting revenues from land sales to developers. And that makes it more difficult for city treasurers to pay off their loans.

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