As more defaults loom, China’s finance regulators face a dilemma

A DOCUMENT CIRCULATING among Chinese banks in early July has caused unease among investors and local officials. Known as “Document No. 15”, the regulatory directive says that banks should stop lending to heavily indebted local-government financing vehicles (LGFVs), companies set up by city or provincial governments to finance building projects and public works. The groups, which have not so far been allowed to default, have about 48.7trn yuan ($7.5trn) in debts, 11.9trn yuan of which is held in fixed-income securities. They routinely use bank loans to pay interest on bonds. Ending the steady stream of credit is a recipe for turmoil. “If banks don’t give them a blood transfusion”, a local investor told Chinese media, “LGFVs will face a default crisis.”

Then the circular vanished, along with most references to it in state media. Some investors believe it may have been released prematurely and that another, less severe version will eventually replace it. Others say banks are carrying out the orders, but fear that the first LGFV default will unleash chaos in the bond market, of which securities issued by LGFVs make up about 10%.