By Steven T. Kargman (Kargman Associates)
In recent years, China has undertaken large-scale infrastructure development both at home and abroad. Overseas, China has undertaken massive infrastructure development around the globe under the umbrella of its widely heralded Belt and Road Initiative (BRI), a signature initiative of Xi Jinping’s tenure as the leader of China. Within China itself, a significant amount of infrastructure development has been carried out at the level of local governments, principally through entities known as Local Government Financing Vehicles (LGFVs).
Yet, this infrastructure development has involved the incurrence of fairly staggering amounts of debt by LGFVs and sovereign borrowers under the BRI. Specifically, LGFVs are estimated to have incurred at least nine trillion dollars of debt (according to an estimate by the International Monetary Fund (IMF)), and approximately a trillion dollars of debt or more has been loaned to sovereign borrowers under the BRI.
This huge overhang of debt has created serious debt sustainability challenges for both BRI sovereign borrowers and LGFVs. Indeed, many BRI sovereign borrowers are currently in debt distress or at high risk of debt distress, and scores of LGFVs across China are experiencing major financial distress.
Nonetheless, the debt distress facing both BRI sovereign borrowers and LGFVs should not come as a complete surprise in light of the weak underlying economics of many of the BRI projects and LGFV-financed projects. Simply stated, many of the infrastructure projects financed by the BRI and LGFV debt have suffered from a lack of fundamental financial/economic viability and thus have been unable to generate the level of revenues or investment returns necessary to service the debt that was used to finance the projects.
Many BRI projects were originally projected to generate high levels of demand for the services or outputs produced by the projects. However, in many cases, the BRI projects have not generated anywhere near the level of demand that was originally expected with the result that the revenues generated by the projects have come in far below the projected levels. For example, far fewer vessels than expected berthed at certain ports developed under the BRI (see, e.g., the Hambantota port project in Sri Lanka), and there was much less cargo and/or passenger traffic on certain railways developed under the BRI than initially expected (see, e.g., the Single Gauge Railway (SGR) in Kenya which connects the capital, Nairobi, with the port of Mombasa on the Indian Ocean).
With the less-than-expected levels of demand and revenues, many sovereigns that borrowed money under BRI have found themselves without the funds necessary to repay the outstanding debt. Thus, a number of BRI borrower countries such as Zambia, Ghana, and Sri Lanka have sought to restructure their outstanding sovereign debt, although these sovereign debt restructurings have turned out to be relatively protracted and contentious affairs.
In addition, there are sovereigns which, although not yet undergoing debt restructurings or not yet having defaulted, have nonetheless turned to the IMF for financial rescue packages and/or otherwise sought funding from certain cash-rich countries. A case in point has been Pakistan, a country which has incurred tens of billions of debt in connection with China’s flagship BRI project, the China-Pakistan Economic Corridor (CPEC)), but which now finds itself in dire financial and economic straits.
In short, many BRI sovereign borrowers have found themselves facing huge debt sustainability challenges. (It should be noted, though, that often BRI sovereign borrowers have also incurred significant amounts of debt from many non-Chinese sources of financing, such as bondholders (local and external), other bilateral creditors including Paris Club and non-Paris Club members (ex-China), multilateral institutions, and so forth.)
For their part, LGFVs have issued bonds and borrowed from banks in order to finance their local infrastructure projects. The problem, however, has been that the LGFV-financed infrastructure projects generally generate relatively meager investment returns, and meanwhile the debt incurred by the LGFVs tends to be fairly expensive. Thus, the cost of the LGFV debt is often much higher than the level of investment returns generated by the LGFV-financed projects. In addition to that mismatch, there is also a basic temporal mismatch: much of the debt incurred by LGFVs is considered short-term in nature, but the investment returns generated by the LGFV local infrastructure projects tend to be generated over the longer term given the long-term nature of the projects being financed.
The Chinese government has recognized the severity of the LGFV debt situation, but so far, the steps taken by the central government might be characterized as somewhat piecemeal and/or limited in scope. Nonetheless, in light of the scale and breadth of the problem affecting LGFVs and localities all across China, a more comprehensive, structural response is sorely needed. Such a response might include, for example, a reassessment of how local infrastructure development is financed as well as a re-examination of how the fiscal relationship between local governments and the central government is configured (particularly with respect to how revenues raised by local governments are allocated between the local governments and the central government).
*This post is based on an article which was originally published in the International Insolvency & Restructuring Report 2024/25. A newer version of article was recently published in AIRA Journal (the journal of the Association of Insolvency & Restructuring Advisors (AIRA)) and is reprinted with the kind permission of AIRA. A briefer version of this post was published on the Harvard Law School Bankruptcy Roundtable (BRT) and is cross-posted with the kind permission of BRT. The article was also previously featured on Columbia Law School’s CLS Blue Sky Blog and the Oxford Business Law Blog.