China Pulls Support From Local Funding Vehicles to Cut Risk

Chinese authorities want failing local government financing vehicles to restructure or go bust if they can’t repay their debts, suggesting the state-linked sector is closer to seeing its first defaults on publicly traded bonds.

The LGFVs should “implement bankruptcy proceedings or liquidation in accordance with the law if they lose their ability to pay,” according to a statement by the State Council -- or China’s cabinet -- posted on Tuesday. Local governments should not rely on LGFVs to finance their activities, the statement said, and LGFVs are banned from accepting documents offering guarantees from local officials or departments.

The statement may further undermine investor faith in implicit support for state-backed companies as doubts over bad-debt manager China Huarong Asset Management Co.’s future continue to roil credit markets.

The Communist Party is making the reduction of financial risk a priority this year as a strengthening economy gives officials room to tackle the nation’s debt mountain. Hidden debt at local levels was elevated to a “national security” issue at China’s annual legislative meetings last month. Local governments had 14.8 trillion yuan ($2.3 trillion) of hidden debt last year, and the figure could climb further this year, according to a government-linked think tank.

“China will definitely tighten its grip on local government financing vehicles as policies were too loose last year,” said Li Yunfei, a credit analyst at Pacific Securities Co.

Weaker local government-backed borrowers in China have been showing increased signs of stress. While LGFVshave yet to default in public debt markets, one local state-linked firm defaulted on commercial bills this year. Chongqing Energy Investment Group Co. failed to pay 915 million yuan of borrowings.

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