China's fiscal reform to bring more credit risk

The fiscal reform has started to limit local governments' ability to extend credit guarantees at a time of slowing domestic growth and tightening global liquidity. Local governments have played a critical role along the credit risk chain. 

Such a chain reaction seems to have begun, SOEs and LGFVs are the guarantors in a majority of private placement bond default cases but have failed to provide credit protection as promised.

They extend credit guarantees to LGFVs, local SOEs and even some private companies that are deemed local champions.

As this critical chain of local governments in China's credit risk situation begins to wobble, there could be significant ramifications for broad financial market stability, says Societe Generale.

Apart from reform, the pressure exerted by the multi-year growth deceleration is already weighing on commercial banks, whose NPLs have doubled since 2012, indicating that private sector debt restructuring has begun and that the process so far is rightly being left to market mechanisms. 

Consequently, for the first time Chinese loan officers are prioritising containing credit risk over growing loan books, and this has gotten in the way of the transmission of monetary policy easing