China raises debt ceilings with measures to address hidden debt

China's MOF has said that it would "raise debt ceilings" to help swap out hidden debt.

China's plan to relieve local government "hidden debt" burdens could enhance transparency and free up capacity for stimulus spending; however, the first-order effect may just shift some government debt, according to S&P Global Ratings. 

"These measures mean China will see larger deficits and higher debt for the time being," said Rain Yin, credit analyst at S&P Global Ratings. 

"The impact on our sovereign rating on China depends on whether these elevated levels persist and turn into a structural component of China's fiscal situation," Yin added. 

China's Ministry of Finance (MOF) has said that it would "raise debt ceilings" to help swap out hidden debt, a form of off-budget borrowing through local government financing vehicles (LGFVs). 

However, MOF officials did not clear whether the debt ceilings would be raised at the local or central level, but past swap programs came from local governments.

"If the Chinese central government issues the new debt, it would deliver the largest positive impact on local finances since local governments' debt burden will directly be reduced," said Wenyin Huang, credit analyst at S&P Global Ratings. 

"If local governments are tasked with the issuance instead, local finances may only see debt shifting from off-budget to on-budget without fundamentally lowering local governments' true debt burden," Huang added. 

The MOF has been trying to clean up local government finances since 2014, allowing provincial-level governments to directly issue debt, unlike in the past where local governments relied on their LGFVs to finance development spending. 

However, local governments' hidden debt continued to accumulate. In 2018, a new round of hidden debt resolution began, spanning the next 10 years. 

Furthermore, the report also noted that policy directives and control since 2018 appear to be stricter on new hidden debts. 

"The new policies look to draw a much clearer line between local government debt and local SOE debt," said Huang. 

"However, if more 'hidden debt' is discovered and recognised as local government debt down the road, downside risks to local governments' creditworthiness could be higher," she added.