China is moving closer to a significant financial rescue

Chinese buses are idling, and the reasons go beyond just a lack of financial support. The announcements of halted services from transport companies in various cities are not just a notice to riders, but also a signal to central authorities that all is not well in the provinces. Local cadres are seeking bail-outs to overcome the economic challenges they face. There is a struggle to avoid bailing out poorly run localities and a concern about the moral hazard involved.

The heart of the problem lies in the property sector. Local governments have been using shrinking budgets to keep construction sites running and drumming up demand by making mortgages more accessible. However, these efforts have not been successful. Home sales have declined and local government land sales have plummeted, putting localities in a financial squeeze. Local-government financing vehicles are struggling to make payments on their substantial debt.

Individual property developers are also hoping for rescues, and small banks require capital injections. The financial situation of certain companies is so dire that police investigations are being prompted. This intertwining of liabilities poses a risk of financial contagion. There are signs that officials are willing to provide financing to eligible developers through banks, bonds, and equities. The central government is showing a willingness to print money in order to prevent a collapse of local governments and the property market.

However, analysts have not yet labeled these moves as a bail-out. While there are efforts to ease the repayment pressure on poor cities through special refinancing bonds, the towering debts are not being wiped clean. There are calls for a true bail-out that would provide developers with ample credit and increase demand for land, giving local governments more income.

The reluctance to bail out everyone indicates that officials are still aiming to protect healthy but illiquid firms and let insolvent ones fail. The desire to weed out ineffective companies has prevented the establishment of a lender of last resort for these firms. The pattern seems to be that the more cash Beijing hands out, the more others come begging for help.

It’s clear that the economic gloom is a widespread concern, and the government is taking measures to address the various issues. The economic landscape in China is in flux, and it will be interesting to see how the government’s actions will impact the financial health of local governments, property developers, and small banks in the coming months.