Defaults in China’s opaque local debt market have surged to an all-time high, catching investors off guard, as they mistakenly assumed these investments carried an implicit guarantee from the state. The rapid rise in defaults has left many retail investors, like 60-year-old Lulu Fang, facing financial ruin after pouring their life savings into these supposedly “safe” products.
This growing crisis sheds light on a corner of China’s financial market that remains poorly understood by many, while exposing vulnerabilities in the country’s broader financial system.
In an effort to spur economic growth and finance infrastructure projects, China’s local governments have long relied on Local Government Financing Vehicles (LGFVs) to raise funds. These quasi-government entities borrow money to build infrastructure such as roads, bridges, and ports, but the investments often fail to generate sufficient income. The problem worsened last year when a wave of debt issued by these financing arms began to go sour.
To address the issue, China’s central government stepped in with a series of measures aimed at stabilizing the market. It allowed local authorities to issue approximately 2.2 trillion yuan ($309 billion) in new bonds to help repay their obligations. State-owned banks were also instructed to extend refinancing support to local governments. These measures brought down borrowing costs to record lows, temporarily alleviating the pressure and encouraging investors to re-enter the market.
However, while these initiatives helped stabilize the public debt market, they failed to address the mounting issues in a more opaque segment: non-standard products, which represent fixed-income investments that are not publicly traded. The result has been a wave of defaults on these products, leaving investors in a precarious position.
Non-standard products, a shadowy and lesser-known aspect of the market, have been a primary vehicle for LGFVs to raise funds outside of conventional bond markets. Although the exact size of this sector is hard to determine due to its opacity, analysts estimate it to be around $800 billion.
In the first nine months of 2024 alone, at least 60 non-standard products tied to LGFVs defaulted or warned of potential repayment risks, a 20% increase from the same period last year, according to data provider Financial China Information & Technology Co. (FCI&T). This marked a new record, surpassing figures that date back to 2019.
While the overall number of defaults is still relatively small compared to the broader financial system, the trend is troubling and suggests that more retail investors may soon find themselves in Fang’s position—losing their life savings on investments they believed were secure.
The human toll of these defaults is becoming increasingly visible. Fang, who owns a small trading company, thought she was making a prudent financial decision when she invested 15 million yuan—her entire life savings—into trust products tied to Guizhou province. With an expected return of 8%, her investment seemed like a much better option than keeping the money in a bank.
But when the products defaulted last year, Fang was left without a safety net. Faced with possible foreclosure on her apartment due to missed mortgage payments, she has made multiple trips to trust companies and government offices, pleading for repayment along with other frustrated investors.
“My life is a total mess now,” she lamented. “I was told these were safe. That was a lie.”
Fang’s story mirrors the plight of many other retail investors who were lured in by the promise of higher returns but ultimately paid the price for betting on non-standard products tied to LGFVs. Like many others, she had assumed the products had some form of government backing, based on their association with local authorities. But in reality, these investments were far riskier than advertised.
The Root of the Problem: Poor Returns on Infrastructure Projects
The root cause of these defaults lies in the nature of the projects financed by LGFVs. Many of these infrastructure investments—such as roads, bridges, and ports—generate little to no revenue, making them dependent on government subsidies or refinancing to stay afloat.
LGFVs have generally prioritized publicly traded bonds, which are often purchased by institutional investors. These bonds, seen as essential to maintaining market stability, have yet to experience a default. In contrast, non-standard products, which are typically sold through private placements to individual investors, receive far less government support.
Of the 60 non-standard products that either defaulted or signaled repayment risks this year, 40 did not disclose the total amount of the debt involved. The remaining 20 products accounted for roughly 4.55 billion yuan in debt.
This lack of transparency is in stark contrast to the more formal, publicly traded bonds, which are seen as a crucial component of China’s capital markets. “Although China has introduced a series of policies to address LGFV debts, the policies need to ensure the repayment of LGFVs’ public bonds as they are part of the capital market,” said Laura Li, managing director at S&P Global Ratings.
The preference for protecting public bonds over non-standard products leaves retail investors, like Fang and others, with little recourse.
There is some hope that relief could be on the horizon for investors who hold defaulted debt. Reports indicate that the Chinese central government is considering allowing local authorities to issue up to 6 trillion yuan in new bonds by 2027 to help refinance off-balance-sheet debt, including LGFV obligations. This move could potentially broaden support for non-standard products, giving local governments more flexibility to meet their obligations.
However, not all analysts are convinced this will happen. Wang Chen, co-founder of Belt & Road Origin (Beijing) Tech Co., a provider of credit-risk analysis, believes that local authorities will continue to prioritize LGFV bonds over non-standard debt when allocating resources. “The new plan’s impact on the non-standard market would depend on the actual scale of policy support, and how such resources could be allocated among different regions and entities,” he explained.
This skepticism is shared by many within the financial sector, who fear that without significant intervention, defaults in the non-standard segment could continue to rise.
The trust industry has been at the center of many of these defaults. Trust products are typically unlisted and sold through intermediaries like banks and securities firms to corporate clients, financial institutions, and high-net-worth individuals. These investments usually promise regular fixed payments and range in duration from six months to five years.
LGFVs have increasingly relied on non-standard products as a way to raise funds, especially as they face stricter regulations on issuing traditional bonds. Non-standard products usually carry higher interest rates, typically between 7-8%, compared to the 3% interest offered by listed bonds. For cash-strapped local governments, the appeal of higher returns comes with higher risks.
“LGFVs definitely have the need to finance via non-standard channels, despite the high costs,” said S&P’s Laura Li. “But their policy priority is low, so the default rate remains at a high level.”
This dynamic has left many investors who opted for trust products at the mercy of a system that lacks clear protections.
The situation faced by retail investors like Jason Lai, who invested 3 million yuan in a wealth management product guaranteed by an LGFV, provides a sobering example of what lies ahead for others affected by the defaults. Lai, who works at a state-owned enterprise in Beijing, has been trying to recover his money since 2019 when the product defaulted.
“Since 2019, I’ve only managed to reclaim about 10% of the principal,” Lai said. He has made several trips to Anshun, the city where the product originated, seeking repayment. His efforts, like those of so many others, have yielded little success.
“I won’t buy any of such products in the future,” he added grimly, reflecting the growing wariness among investors about non-standard debt.
