Defaults in a relatively obscure part of China’s local debt market have reached record levels, catching investors off guard who believed the securities carried implicit backing from the state.
Last year, China’s central government moved to address growing concerns over mounting bad debt from local government financing vehicles (LGFVs). It authorized local governments to issue 2.2 trillion yuan ($309 billion) in new bonds and instructed state banks to provide refinancing support. This intervention brought borrowing costs to historic lows and reignited investor interest. However, one segment of the market—non-standard debt products—remained vulnerable. Defaults in this category, which includes fixed-income investments not publicly traded, have surged to unprecedented heights.
Though the true scale of the non-standard debt sector is unclear, analysts estimate it at approximately $800 billion. In the first nine months of this year alone, 60 non-standard products linked to LGFVs defaulted or signaled repayment risks—a 20% increase from the previous year, according to data from Financial China Information & Technology Co. This marks a record high in data dating back to 2019.
The impact has been particularly severe for retail investors.
One such investor, 60-year-old Lulu Fang, lost her entire life savings of 15 million yuan after purchasing trust products tied to Guizhou province. Expecting an 8% return, she instead saw her investment vanish when the products defaulted. Now facing foreclosure on her apartment in Shenzhen, Fang has joined over 100 other investors in petitioning both the trusts and government offices for repayment. “My life is a total mess now,” she said. “I was told these were safe. That was a lie.”
LGFVs have been central to funding infrastructure projects across China, such as roads and ports. However, many of these projects do not generate revenue, leaving the LGFVs dependent on government support to meet their obligations. While there is little transparency on the total debt issued by LGFVs, out of the 60 non-standard product defaults reported this year, only 20 disclosed a combined total of 4.55 billion yuan.
This stands in sharp contrast to LGFVs’ publicly traded bonds, which are favored by institutional investors and have yet to see a single default. Local governments have prioritized supporting these public bonds over the less transparent non-standard products, which are typically sold through private placements and attract less official intervention.
“China has introduced policies to address LGFV debt, but those measures are primarily designed to protect LGFVs’ public bonds because they are integral to the capital market,” said Laura Li, managing director at S&P Global Ratings. “A default on public bonds would threaten financial and social stability.”
There may be some relief on the horizon for investors in defaulted non-standard debt. The central government is reportedly considering allowing local authorities to issue up to 6 trillion yuan in bonds through 2027 to refinance off-balance-sheet debt. This could potentially widen support for non-standard products, though analysts remain skeptical about whether such aid will materialize.
“If efforts to reduce hidden debt proceed, local authorities will still prioritize LGFV bonds over non-standard debt,” said Wang Chen, co-founder of Belt & Road Origin (Beijing) Tech Co., a credit-risk analysis firm. “The impact on non-standard debt will depend on the scale of policy support and how resources are distributed.”
Many of the defaults have occurred in China’s trust industry, where products are sold to high-net-worth individuals and institutions. These trust products, often unlisted and sold by banks or securities firms, typically offer annual or semi-annual fixed payments over periods ranging from six months to five years. Investors are attracted by the higher returns, with non-standard products offering 7-8% interest compared to just 3% for listed bonds.
“LGFVs need non-standard financing channels due to cash-strapped local governments and stricter regulations on bond sales,” noted S&P’s Li. “However, the priority for policy support is low, which keeps default rates high.”
For retail investors like Fang, the prospect of recovering losses remains slim. Jason Lai, another investor, lost most of his 3 million yuan investment in an LGFV-guaranteed wealth management product five years ago. Despite making multiple trips to Anshun in pursuit of repayment, Lai has only managed to recover 10% of his principal.
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