China’s local government financing vehicles are rushing to buy vast quantities of land with borrowed funds, bailing out cities and provinces struggling for cash after an exodus of debt-stricken private sector developers.
The spending spree has been unleashed in the run-up to President Xi Jinping’s expected appointment to an unprecedented third term next month and highlights efforts to boost the pandemic-hit economy, which grew just 0.4 per cent year on year in the second quarter.
Local governments have traditionally relied on LGFVs to support growth by spearheading infrastructure investment. Now, the financing vehicles are being called upon to prop up the real estate sector, which accounts for about one-third of total economic output.
According to official data, land acquisitions by LGFVs rose to Rmb400bn ($57bn) in the first half of the year, up more than 70 per cent compared with the same period in 2021. This is despite overall land purchases, which have previously been dominated by private developers, falling by almost a third as Beijing cracks down on real estate speculation.
The buying spree is intended to help cash-strapped local authorities, for whom selling land is an important source of income. But the LGFVs, which play a critical role in funding long-term infrastructure development, are being forced to borrow more from state banks and issue bonds to finance the deals.
“I view this as an indirect government bailout that’s politically acceptable,” said Andrew Collier, managing director at Orient Capital Research in Hong Kong.
Most LGFVs, which typically have little experience in property development, are leaving their newly purchased plots idle. This, combined with the larger housing market meltdown, means the short-term relief that local authorities get from the financing vehicles’ land purchases ultimately risks bigger problems for China’s already faltering economy.
“The governments are basically asking the LGFVs to pay inflated prices [for land] in a declining market, which isn’t sustainable,” said Collier.
LGFVs are known for their sluggish financial performance, and their emergence as major players in land auctions comes as private developers are forced to cut back because of the industry-wide debt crisis.
A plunge in land sales and softening prices have exacerbated the pressure on local governments already grappling with shrinking tax bases amid the wider economic downturn. This has led many cities and provinces to ask LGFVs to fill the vacuum left by private developers.
“We have played a critical role in keeping the land market and government revenues from falling off a cliff,” said an executive at Yueyang Urban Construction and Investment. The LGFV, based in central Hunan province, spent Rmb1.3bn on land purchases in the first half of this year.
Official data show LGFVs accounted for almost a quarter of land sales in the first half of this year, compared with 9 per cent in the same period a year ago. The ratio exceeded 50 per cent in some less-developed small cities.
But the buying boom has come at a steep cost for the LGFVs. To make up for the lack of bidders, many cities have raised the minimum price for land auctions. That has often forced LGFVs to pay a premium even as the market is weakening.
In Weihai, a city in eastern Shandong province, an executive at Huancui District Urban Development Investment said his LGFV paid at least twice the market price for a suburban plot at the end of last year. “We made the investment for political reasons, not business ones,” the executive said.
State banks have provided financial firepower for the shopping spree.
Most LGFVs face cash flow constraints as they derive the bulk of their income from government-backed infrastructure projects with long-term horizons for returns. In the meantime, state lenders are willing to either issue loans to LGFVs against land as collateral or buy the latter’s bonds in the hope authorities will step in if a crisis occurs.
“We have better access to credit than the government,” said the executive at Yueyang Urban Construction and Investment, citing Beijing’s restrictions on borrowing by local governments.
But actually building on their newly purchased lots remains a challenge. Only about one in five LGFVs has experience in real estate development, according to China Index Academy, a Beijing-based consultancy.
That has prompted many LGFVs to put off development plans. Private developers, by contrast, often start construction soon after winning a bid.
In the southern city of Guangzhou, building activity has not started at any of the 10 land blocks purchased since late last year by LGFVs, according to people familiar with the developments.
“We don’t know much about real estate,” admitted an executive at Guangzhou Metro Group, which has spent more than Rmb2bn buying land since the end of last year. “It is in our best interest to keep the land and sell it for a profit when the market recovers.”