Recently, the municipal bond market has once again been rocked by controversy, with the scale of local government debt and the debt-repayment capacity of local governments once again sparking heated debate.

Local government debt includes general local bonds, special-purpose bonds, and various forms of implicit debt such as urban investment bonds. While the exact scale of this debt remains a matter of debate, its growth trend is undeniably rapid.

As a key financing tool for local governments, urban investment bonds have played a vital role in promoting economic development and urban construction. However, with the expansion of debt, slowing economic growth, and challenges to land-based fiscal revenue, risks associated with urban investment bonds have begun to surface, becoming a major issue for local economic development.

Against this backdrop, various regions are actively exploring debt-reduction models tailored to their local characteristics.

01 The Rapid Expansion of Urban Investment Bonds

The risks associated with urban investment bonds have accumulated gradually, primarily stemming from the following factors:

First, the debt scale has expanded too rapidly.

For many years, in pursuit of economic development and enhanced urban competitiveness, local governments have stimulated the economy through measures such as accelerating infrastructure construction. Faced with a mismatch between fiscal authority and administrative responsibilities, local governments have met their funding needs by expanding the scale of implicit debt, primarily through urban investment bonds.

When the pace of urban investment bond issuance outstrips the growth rates of the economy and fiscal revenue, the exposure of risks becomes inevitable.

Second, a decline in revenue from land-related fiscal sources.

The primary sources of revenue for both local governments and urban investment platforms are income from primary land development and land sales. As the real estate market has slowed, land sales and related revenues have declined, making the debt rollover model of urban investment platforms unsustainable.

Taking Kunming—which has recently drawn significant attention—as an example, government fund budget revenue, primarily derived from land sales, stood at 14.61 billion yuan in 2022, a 68% year-on-year decline.

Third, the management and profitability of urban investment companies are unstable.

Since urban investment companies are often tasked with investment, financing, and urban development functions—including the execution of non-profit public projects—their cash flow struggles to cover the principal and interest on urban investment bonds. They rely on government subsidies and other policies to stay afloat; once government financial support falters, debt repayment pressures become acute.

02: Abolish Rigid Redemption or Maintain the "Faith in Urban Investment Bonds"?

In accordance with the new Budget Law and "Document No. 43," urban investment bonds have been explicitly decoupled from local government credit. The role of urban investment companies has shifted from local government investment and financing institutions to market-oriented entities, and local governments no longer provide a safety net for these bonds.

In practice, however, the market still views urban investment bonds as high-credit-rated bonds backed by local governments. It remains difficult for urban investment companies to become fully market-oriented enterprises.

Since 2011, the national urban investment bond market has expanded rapidly, with annual growth rates consistently exceeding 10%. By the end of 2022, the total volume of urban investment bonds nationwide had grown more than sevenfold compared to 2011. Urban investment bonds have become the primary form of local government debt, with their scale significantly exceeding the combined total of general-purpose bonds and special-purpose bonds.

It is worth noting that there have been no default cases involving standard urban investment bonds to date, indicating that these bonds remain high-grade credit bonds backed by local governments. However, defaults on non-standard financing by urban investment companies occur from time to time, and there are also many instances of banks extending loan maturities or adjusting repayment terms.

The market is currently widely concerned about the growth of local government debt and the decline—or even negative growth—in fiscal revenue, particularly in the financially weaker provinces of Northeast China and the central and western regions, where yields on urban investment bonds are generally higher than in the developed eastern provinces. In 2022, land sale proceeds in 13 provinces covered less than 100% of government debt interest payments (compared to only 5 provinces in 2021), making the financial strain even more evident.

Against the backdrop of an economic recovery falling short of expectations, investors’ risk appetite has declined significantly. Consequently, local governments must ensure the timely repayment of urban investment bonds. Defaulting would not only fail to resolve debt issues but would also worsen the regional credit environment, making it more difficult and expensive for local state-owned enterprises to secure financing.

From the perspective of regional economic development, government departments still need to continue borrowing to achieve stable economic growth and must maintain government creditworthiness; they cannot default lightly. Therefore, there is an urgent need to boost the confidence of urban investment bondholders. The first step is to ensure that these bonds do not default, which implies that urban investment companies must possess the ability to refinance old debt with new, low-cost borrowing.

The central government’s principle of “whoever’s child, they must take care of it” implies that it will not provide a blanket guarantee for local government debt, but will offer certain “safety net” support to provinces in difficulty. This includes strong policy support for “debt restructuring,” such as helping local governments reduce debt costs and extend debt maturities, utilizing low-interest funds from banks to lower debt costs and make debt rollovers more manageable.

On March 1 of this year, in its response to Proposal No. 00503 submitted to the Fifth Session of the 13th National Committee of the Chinese People’s Political Consultative Conference, the State-owned Assets Supervision and Administration Commission (SASAC) stated that it would introduce institutional regulations and operational guidelines at an appropriate time to explore effective methods and channels for the standardized divestment of state-owned equity stakes. It aims to fully leverage the advantages of limited partnerships to support the innovative development of state-owned enterprises.

At this critical stage of China’s economic transformation, maintaining the creditworthiness of local governments and preventing regional financial risks is of paramount importance. Therefore, until urban investment companies have fully “disengaged” from government departments, the “faith” in urban investment bonds must be sustained.

03 Stimulating Investment vs. Stimulating Consumption: Which Should Government Spending Prioritize?

The global economy is entering a phase of high volatility and low growth, and export growth will decline accordingly. The importance of expanding domestic demand—which includes consumption and investment—is beyond doubt.

Looking at the debt structure of China’s local governments, general-purpose bonds account for a very small portion—only about 14 trillion yuan—while the combined scale of special-purpose bonds and urban investment platform debt exceeds 80 trillion yuan, with the latter primarily directed toward infrastructure investment. However, as the scale of infrastructure projects expands, their marginal returns are diminishing.

For example, the median return on investment for urban investment platforms has fallen from 3.1% in 2011 to 1.3% in 2021.

There has long been debate over whether infrastructure investment is ahead of its time, but this is quite evident in certain sectors.

For instance, China ranks first globally in passenger vehicle sales, and the total length of its expressways continues to grow. In 2020, the number of vehicles per kilometer of expressway in China was approximately 1,422, compared to 1,830 in the United States. With relatively fewer vehicles on the road, this suggests that too much road infrastructure may have been built.

Take Guizhou’s expressways as an example: by the end of 2022, the total length of expressways in Guizhou reached 8,331 kilometers, while Japan’s total expressway length was only 7,800 kilometers. However, Guizhou’s total GDP in 2022 was less than one-fifteenth of Japan’s.

Guizhou currently faces severe pressure to reduce debt and clearly cannot continue to borrow heavily for infrastructure projects. The nation as a whole is also facing pressures such as shrinking demand and weakening economic expectations. Therefore, when expanding fiscal spending through borrowing, the approach should be problem-oriented, with the goal of improving quality and efficiency, and optimizing the structure of expenditures.

For example, when the economic stimulus effect of infrastructure investment is significantly lower than that of consumption promotion, should priority be given to stimulating economic recovery through consumption promotion? For instance, by distributing hundreds of billions or even trillions of yuan in targeted consumption vouchers to low- and middle-income households, we could not only drive investment through consumption but also boost employment through investment, thereby further strengthening economic expectations.

With private investment now experiencing negative growth and youth unemployment exceeding 20%, in accordance with the Central Economic Work Conference’s directive to “prioritize restoring and expanding consumption,” it is necessary to increase household income through multiple channels—such as issuing consumption vouchers and raising basic pension payments—to alleviate consumers’ concerns and thereby boost consumption’s contribution to GDP.

04 Solutions for Resolving Local Government Financing Vehicle (LGFV) Debt

In 2018, the Ministry of Finance’s “Instructions for Reporting on the Comprehensive Inventory of Local Government Debt” listed six methods for resolving debt, as follows:
1. Allocate fiscal funds for repayment

2. Repayment through the disposal of equity interests in state-owned operating assets
3. Repayment using project carryover funds and operating income
4. Repayment by converting the debt into corporate operating debt
5. Through debt restructuring or extension

6. Through bankruptcy reorganization or liquidation

In recent years, various regions have also combined these six debt resolution methods to continuously explore debt resolution models tailored to their regional characteristics.

Guizhou’s Unique “Moutai Debt Resolution”

Guizhou Province has resolved debt by transferring equity interests in state-owned operating assets through the “Moutai Debt Resolution” approach. Since 2019, the Moutai Group has implemented a series of supplementary debt resolution measures, which can be broken down into three steps.

Step 1: Equity Transfer.

Moutai Group has carried out two rounds of equity transfers without compensation. The transferee companies then reduce their holdings and sell shares to generate cash flow, thereby alleviating debt pressure.

Step 2: Bond Issuance.

Moutai Group chose to raise funds through bond financing. This marks not only the Group’s first bond issuance but also the allocation of proceeds toward acquiring equity in Guizhou Expressway, repaying interest-bearing debt, and supplementing working capital needs—further helping to alleviate local debt pressures.

Step 3: Fixed-income investments.

In June 2020, the Guizhou Banking and Insurance Regulatory Bureau approved Moutai Group’s financial company to expand into fixed-income securities investment and other businesses, further alleviating local urban investment company debt pressures and enhancing the market recognition of Guizhou Urban Investment to a certain extent.

Guizhou Province has also attempted to alleviate debt pressures through bank loan restructuring. On December 30, 2022, Zunyi Road and Bridge Construction (Group) Co., Ltd. issued an announcement regarding the advancement of bank loan restructuring. To alleviate the company’s short-term debt repayment pressures and optimize its debt structure, and with the preservation of creditors’ rights as a prerequisite, the company restructured 15.594 billion yuan in bank loans following amicable and equal negotiations among all parties.

Following the restructuring, the term of the bank loans was adjusted to 20 years, with interest rates ranging from 3.00% to 4.50% per annum. For the first 10 years, only interest payments are required, with no principal repayment; for the subsequent 10 years, principal will be repaid in installments.

This debt restructuring implements the guidance set forth in State Council Document No. 2, which states: “In accordance with market-oriented and rule-of-law principles, and on the premise of fulfilling local governments’ debt resolution responsibilities and avoiding the creation of new local government hidden debt, financing platforms are permitted to negotiate with financial institutions to adopt appropriate measures such as extensions and debt restructuring for eligible existing hidden debt to maintain cash flow.”

Yunnan Explores the “Health and Tourism Model”

Yunnan Province has similarly utilized the “Baiyao Debt Resolution” model to transfer equity interests in state-owned operating assets to achieve debt resolution.

On December 8, 2021, the Yunnan Provincial State-owned Assets Supervision and Administration Commission transferred its 100% equity stake in Yunnan Provincial State-owned Equity Operation and Management Co., Ltd. to Yunnan Investment Holding Group Co., Ltd. (hereinafter referred to as “Yun Tou Group”). Following this transfer, Yun Tou Group indirectly holds a 25.04% stake in Yunnan Baiyao, becoming one of the company’s largest shareholders alongside others, thereby alleviating Yun Tou Group’s debt pressure.

Yunnan Province has also developed a distinctive “Health and Tourism Model.”

Bonds issued by Yunnan Kanglv once yielded over 30%, and the market had previously expressed concerns about potential defaults on these bonds. However, Yunnan Kanglv resolved the bond issue through an unconventional approach: early redemption.

In September 2022, Yunnan Kanglv Group made early repayments on bonds issued by the group and its subsidiaries, with the total amount of bonds subject to early repayment reaching 8.653 billion yuan.

This debt resolution initiative by Kanglv Group holds significant implications for provinces with weaker economies:

With support from higher-level State-owned Assets Supervision and Administration Commissions (SASACs) or finance departments, the company replaced high-cost bonds and non-standard financial products with low-cost bank loans, buying time to create breathing room. When the bond market financing environment improves and the company’s operations significantly recover, it may return to the bond market to raise funds.

Tianjin Holds Consultative Meetings

To alleviate regional debt pressures and enhance market confidence, the Tianjin Municipal Government has also taken proactive measures. In 2021 and 2022, it held symposiums to demonstrate the government’s determination to uphold the credit environment. Additionally, Tianjin’s local financing platforms, relevant departments, and enterprises have repeatedly engaged in bank-enterprise cooperation with local branches to boost market confidence.

In 2023, the Tianjin Municipal Government successively signed comprehensive strategic cooperation agreements with the four major state-owned banks—Industrial and Commercial Bank of China (ICBC), Agricultural Bank of China (ABC), China Construction Bank (CCB), and Bank of Communications (BOCOM)—to leverage financial institutions in improving the market financing environment and boosting investment confidence.

Shandong Receives Frequent Policy Support
Shandong Province has received policy support on multiple occasions to guide high-quality local development and prevent and mitigate financial risks.Since September 2022, policy documents such as State Council Document No. 18, Ministry of Finance Document No. 137, and China Banking and Insurance Regulatory Commission Document No. 11 have provided guidance on Shandong’s rational development and debt resolution approaches. These measures aim to promote the establishment of a rational development model in Shandong, assist in building a debt management system, comprehensively reduce regional debt risk levels, and advance the resolution of risks at key enterprises as well as the settlement of legacy issues.