From roads, bridges, subways, you name it
all the infrastructure China has built over the past decade
is bigger than anything the world has ever seen before
. That activity has been a big driver of China's
very fast economic growth in the last decade, the
companies which borrowed money to finance these developments are called
LGFES or local government financing vehicles. And what happens
to them next will help determine the future of China's
entire economy. Borrow money from banks or they sell
bonds in total. The amount they owe is about
equal to half of China's GDP LGS have been really
good at transforming China's urban environment, but they've not
been very good at making money. And that's because
a lot of the infrastructure they build is either free
or very cheap for the public to use. So
they'll probably never be able to pay back all the
debt they've borrowed to do that building. But that's
actually ok to understand why. Remember that the debt
is part of the wealth of Chinese banks. They're
happy as long as the LGF fees are giving them
a steady income stream by paying their interest. And
the LGF fees have been able to keep paying their
interest. Thanks to help from their local government owners
, a growing economy means more government income, which
they hand over to the LGF fees to help them
pay their interest. And when the time comes for
them to pay the principal on their debt, the
banks have been happy to say, don't worry,
you can pay us later. This has all worked
pretty well. LGF fees have always been able to
meet payments due on their bonds. But a few
years back, China's leaders in Beijing started worrying that
LGS are wasting resources that could be used better elsewhere
in China's new high tech sectors, for example.
So it sent a message to local governments stop promising
to support your LG fees if they get into trouble
and see if they can support themselves. But because
local governments had stopped promising to be a backstop,
the bank started thinking maybe we won't roll over the
debt like we did before and if we do,
we'll demand a higher interest rate. The problem is
that LG in poorer areas of China are never going
to be able to support themselves. And at the
same time because of the end of a boom in
apartment sales, China's local governments have seen their income
slowing dramatically and that means that they have less money
to hand over to the LGF fees that they own
. That could mean LGF fees fail to pay interest
on their bonds suddenly making those bonds, a lot
less valuable and banks would become less wealthy than they
thought that they were. Now, we can all
remember from the 2008 financial crisis, what happens when
banks lose their wealth? It can be a huge
shock to the financial system. In the worst case
, they can stop lending entirely crushing the economy.
Now, obviously China's leaders sitting in Beijing don't want
that to happen, but they also don't want to
just bail out all of these companies. They think
that that would send the wrong message about wasteful borrowing
. Local governments are going to have to keep doing
everything they can to ensure their LG fees carry on
making their payments. But if Beijing isn't going to
bail them out, then local governments will need to
cut down spending on other areas including on infrastructure to
make sure that the bond payments are made. So
what does all of this really mean? Remember that
infrastructure boom over the last decade, we won't see
it repeated ahead. And that means China will grow
more slowly over the next decade.