In recent years, China has undertaken massive infrastructure development at home and abroad.  Under its widely heralded, globe-spanning Belt and Road Initiative (BRI), China’s financial institutions have financed infrastructure projects in numerous countries around the world.  Separately, through its so-called Local Government Financing Vehicles (LGFVs), China has financed infrastructure development at the local level across the breadth and width of the country.

Nonetheless, with this massive infrastructure development has come truly staggering amounts of debt.  The International Monetary Fund (IMF) has estimated that LGFVs have incurred approximately $9 trillion of debt, and under the BRI program, developing and emerging economies have incurred hundreds of billions of dollars of debt.  The problem, however, is that this mountain of debt has posed major debt-sustainability challenges  for BRI countries and LGFVs, as reflected in the fact that many BRI countries are now facing serious sovereign debt distress and numerous LGFVs are now facing major financial distress.

Fundamentally, this problem can be traced in many ways to the underlying lack of economic viability of the infrastructure projects for which the debt was incurred.  In many cases, BRI projects have failed to generate anticipated revenues, and this has made it difficult for the BRI borrower countries to service their BRI-related loans from major Chinese financial institutions, including China’s so-called “policy banks” (e.g., China Development Bank and Export-Import Bank of China) and its large state-owned commercial banks (e.g., ICBC, Bank of China, China Construction Bank, etc.).  For example, when a port, railway, or highway project receives less than the expected volume of traffic and therefore generates less than its projected revenues, its fundamental economic viability may be  called into question and debt sustainability difficulties may arise as a consequence.

For LGFVs, there has long been a mismatch between the rate of return they generate and the interest rate on the debt that was used to finance them.  The LGFV-financed projects have generally generated negligible investment returns, but this has proven to be highly problematic since the costs of servicing debt have often exceeded these investment returns.

In the past, LGFVs were able to bridge this gap with funding from local governments, but this option has become increasingly untenable as local governments now have fewer financial resources at their disposal with which to support LGFVs. In particular, revenues from property sales — traditionally a major source of revenue for local governments — have fallen sharply, and the recent widely discussed property crisis in China has only exacerbated this situation.

The LGFV debt crisis, which the Chinese leadership from President Xi Jinping on down has recognized, could have serious implications for China’s financial system.  Chinese banks have loaned substantial sums of money to the LGFVs, and the banks have also purchased large volumes of debt issued by the LGFVs.  Thus, if the LGFVs are unable to service their debt (whether in the form of bank loans or bonds), Chinese banks might face the possibility of significant losses.  This is certainly not a prospect that Chinese economic policymakers would welcome at the present time in light of the  fragile state of the Chinese economy today with its sluggish growth, deflationary pressures, and a property slump (if not collapse), as well as in view of the losses that banks have already suffered as a result of China’s property crisis.

In a new article, I review the major debt sustainability challenges facing BRI borrower countries and LGFVs generally.  The article focuses on how these challenges trace in no small part to the troubled economics of the underlying infrastructure projects for which massive amounts of debt were incurred.

The article also reviews various non-economic and non-financial reasons, such as geopolitical considerations, for why Chinese financial institutions might have loaned money to BRI borrower countries for projects with potentially questionable economic viability. Those reason might include, for example, China’s desire to maximize access to strategically located ports abutting the Indian Ocean pursuant to a so-called “string of pearls” strategy.  Further, the article discusses why LGFV infrastructure projects in China have proven to be uneconomic, and how this has resulted in huge unsustainable debt burdens for LGFVs.

The article concludes by proposing a number of structural options  that Chinese policymakers might consider to more effectively address the LGFV debt crisis. Those options include establishing a national quasi-governmental restructuring agency, re-evaluating the fiscal relationship (and the related allocation of revenues) between local governments and the central government, reviewing promotion criteria for local government and local party officials, and considering the creation of new financing platforms at the national level to assist in the financing of local infrastructure in China.

This post comes to us from Steven T. Kargman, founder and president of Kargman Associates/International Restructuring Advisors. It is based on his recent article, “A Tale of Two Debt Burdens: A Day of Reckoning for China’s Debt-Fueled Infrastructure Development at Home and Abroad,” published in International Insolvency & Restructuring Report 2024/25 (IIRR) and available here.  The article is reprinted with the kind permission of the publisher of IIRR, Capital Markets Intelligence.