Local government financing vehicles (地方融资平台公司 LGFVs) have been major recipients of the credit growth in China over the last five years. But what exactly are these financing vehicles doing with this credit?
We have asserted LGFVs are mostly investing in long term projects that have not yet (or may never) generate sufficient cash flow to cover the cost of capital. As a result, many of them have (or will struggle) to service debt without intervention from local governments.
Some economists have a different interpretation. Local governments financing vehicles are in fact hoarding most of the money they borrowed and have plenty of cash to payback creditors.
Over the past three years deposits of government institutions and social organizations (机关团体存款) have exploded. A reclassification in 2010 and 2011 dramatically increased the size of these deposits to 14.6 percent of all deposits (or Rmb 14.7 trillion). Some believe the increase is mostly attributable to the inclusion of local government financing vehicles as part of the reclassification. If so that would mean local government financing vehicles have plenty of cash and will not struggle to service their debt.
However, this theory has some fundamental problems. First, a large portion of the Rmb 14.7 trillion in deposits is attributable to public institutions (事业单位) not LGFVs. The key change in the reclassification was moving the deposits of public institutions from non-financial enterprises (非金融公司存款) to deposits of government institutions and social organizations (机关团体存款). Public institutions are actually very broad (including schools, hospitals, and research institutes at both central and local levels). These institutions along with government departments are the entities that establish LGFVs and infuse them with cash or assets. They often receive money from the state budget, hold public assets, and can borrow freely from banks. Public institutions also require a good deal of liquidity because they are providing social services. The fact that they have large cash reserves is comforting but does not mean that this cash is available for investment projects.
Second, there is strong evidence that LGFVs do not have a lot of cash. Macquarie Securities aggregated the financial information of all 850 financing vehicles with corporate bond issuances. This group of LGFVs is only 10 percent of all companies but accounts for 76 percent of all LGFV bank borrowing and 100 percent of all corporate debt. But their cash holdings were only Rmb 2 trillion at the end of 2012. If the ratio of cash holdings to bank debt in the LGFVs outside this sample is the same for companies outside the sample the total cash holdings of LGFVs would be only Rmb 2.6 trillion, less than the 13 trillion in deposits held by public institutions, government departments, and social organizations.
Third most of the borrowing by LGFVs is in fact being used to invest in local projects. For example, indicators of city infrastructure provided by the Ministry of Housing and Urban Development show a rapid increase in operational infrastructure in 2010 in response to the infrastructure investment boom in 2009. Notably, urban transit networks grew by 254 percent between 2008 and 2011.
Macquarie Securities’ microdata also shows LGFVs are spending on investment projects – rather than hoarding cash. The value of projects under-construction for LGFVs has grown by 68 percent between 2012 and 2009, faster than 28 percent growth in cash.
Local government financing vehicles should not be confused with public institutions and government departments. LGFVs are not hoarding cash. They have invested most of their funds in infrastructure and are struggling to generate enough cash to pay off loans. What the reclassification shows us is that public institutions and government departments have plenty of cash on hand, while local government financing vehicles continue to struggle.