First LGFV default likely this year

In the past years, local governments have borrowed heavily to finance infrastructure projects. If defaults on debt repayments occur, some experts say it could cause a confidence crisis. [Photo by Chen Zhuo / for China Daily]

China is likely to see the first case of a default by a local government financing vehicle this year, said Zhang Zhiwei, chief China economist with Deutsche Bank AG.

"The sooner the default happens, the better it is for investors ... as it could improve the pricing of risky assets and help policymakers solve the high financing costs in the market," Zhang said during a news conference in Beijing on Monday.

Shandong province recently issued a regulation which stated that the provincial government will not bail out governments at county level in case of debt default, making it the first province in China to step up curbs on local government financing vehicles.

Chinese LGFVs have issued debts to purchase land from local governments and for massive property development, which has created an oversupply in many second-and third-tier cites. Default risks for LGFVs started increasing after the nation's property market started cooling.

Zhang said the government had sent an important signal of regulating LGFVs, which have led to high financing costs and low efficiency in capital allocation.

"If money is used and invested more efficiently by private enterprises, China will have greater room to maintain 7 or 8 percent of GDP growth and avoid bad debts," he said.

Deutsche Bank has forecast that fiscal revenue of local governments in China may decline by 2 percent this year, the first contraction since the country's tax system reform in 1994.

The drop in land sales due to the cooling property market is the main reason for the decline. At the same time, the country will also see a sharp disparity in the fiscal revenue of local governments, the bank said in a report.

Top-tier cities and those that have diversified their revenue sources away from land sales will continue to see double-digit fiscal expansion, while governments of some second-and third-tier cities with property oversupply will face serious fiscal challenges.

The national fiscal revenue will grow at an average pace of 5 to 8 percent in the next five years, the bank said.

China's GDP growth is likely to hit 6.8 percent in the first two quarters of this year and rebound back to 7 percent in the second half of the year. "We expect policymakers to cut both interest rate and banks' reserve requirement ratio twice in 2015," Deutsche Bank said.