Follow the (commercial) paper trail

In last week’s Government Work Report, Premier Li Qiang said local government debt risks are coming under control.

• That assessment aligns with the latest data on commercial acceptance draft (CAD) defaults.

Refresher: CADs are tradable, zero-coupon IOUs with a fixed maturity of six months or less (see our October 20 note).

• Local government financing vehicles (LGFVs) issue CADs to pay suppliers and contractors in lieu of cash.
• The Shanghai Commercial Paper Exchange (SHCPE), a unit of the central bank (PBoC), publishes monthly lists of CAD defaulters with unsettled debts and more than three overdue payments in the previous six months.

LGFVs are more likely to default on CADs than bonds, as bond defaults can trigger creditor negotiations and debt restructuring.

• This makes CAD defaults an early warning sign of financial stress.

The stress appears to be under control:

• At the end of February, 56 LGFVs were listed as CAD defaulters, down from 58 in January.
• This marks the second consecutive month of improvement, a trend unseen since 2022.

ICYDK: Defaults grew rapidly last year.

• By December, the number of LGFV defaulters had nearly tripled from January 2023.
• Provinces with the highest volume of LGFV defaults, like Guizhou and Yunnan, were among the recipients of additional bond quotas to refinance their “hidden debt.”

Get smart: Government arrears like overdue CADs burden private sector companies, souring business confidence.

• Government policies to extend loan maturities and lower debt service payments are containing risks for now, but truly resolving the local government debt issue will be a long-term endeavor.