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China’s heavily leveraged banks in trouble after government launches debt clean-up drive

China's local governments and their financing arms come under pressure with rising debt level

As China rolls out frantic measures to clean up bad debts in its local governments and their financing arms known as local government financing vehicles (LGFVs), non performing assets level in the country’s banking sector could rise. The LGFVs have primarily received loans from the banks on the basis of mere guarantee of repayment.

According to estimates, the unaccounted debt of the local government and their LGFVs which accounts for loans and bonds, touched $7 trillion by 2020-end. This is more than 40 per cent of China’s GDP.

It is no secret that shadow banking has blossomed in China fueling – in many areas artificially fueling — the property sector that accounts for about 30 per cent of the country’s GDP. The near collapse of the real estate sector in the world’s second largest economy has prompted many analysts to compare the Evergrande episode with US’ Lehman Brothers’ crash. In 2008, world economy was severely dented by the US housing crisis.

Also read: China's real estate sector set for big shakeup with State Owned Enterprises now in pole position

Besides, there have been several instances when China’s regional governments, in a bid to skirt the borrowing limits transferred chunks of their assets to these LGFVs.

Though China collapsing housing market, accounting for about 30 per cent of the GDP, has been the main trigger, the outbreak of the Covid 19 pandemic impacting the repayment schedule of several countries that received loans from Beijing either for the Belt and Road Initiative or otherwise had already started to worry the country’s policymakers.

Forbes in a report said that even though China’s government loosened credit, opened up mortgages, and funneled money to bankrupt developers, they managed only to make the decline slightly less extreme.

The LGFVs were created after the 2008-09 global meltdown to fuel credit into the infrastructure sector within the country and outside. The problem arose as they have been allowed to bifurcate existing regulations applicable for other lending establishments.

Also read: An ageing China is going all out to woo young couples to have three children

In 2018, Gan Li, of Chengdu’s Southwestern University of Finance and Economics told Bloomberg that no other country had such a high vacancy rate and in case of a crack, the real estate market would collapse like a flood.

The International Monetary Fund in its annual review said that several imbalances in the Chinese economy have worsened which will lead to a delay in the country’s transition to consumption-led growth.