China’s Hidden Debt Shrinks, but LGFV Operational Debt Poses New Risk
China’s ambitious campaign to clean up its hidden local government debt is making significant headway, but a more intractable challenge is emerging: the resolution of 14.8 trillion yuan ($2.1 trillion) in operational debt held by Local Government Financing Vehicles (LGFVs), complicated by a tangle of high-interest, non-standard loans that banks are reluctant to restructure.
According to Caixin Global, Finance Minister Lan Fo’an reported that the outstanding balance of hidden local government debt fell by 3.8 trillion yuan from the end of 2023 to 10.5 trillion yuan by the end of 2024. The number of LGFVs on the official list has also plummeted, shrinking by 71% from March 2023 to September 2025.
The 12 Trillion Yuan Debt Resolution Package
In late 2024, Beijing rolled out a sweeping 12 trillion yuan ($1.7 trillion) policy package to resolve hidden local government debt. The primary mechanism involves special-purpose bonds (SPBs) issued by local governments to swap high-cost hidden liabilities for lower-interest, longer-term official debt. With at least 4 trillion yuan in SPB funds still available before 2028, market watchers are confident that Beijing will meet its mid-2027 deadline for eliminating hidden debts.
A government report submitted to the National People’s Congress in March 2026 showed that more than 82% of LGFVs had been phased out and their outstanding operational financial debt reduced by more than 74%.
The Emerging LGFV Operational Debt Challenge
While progress on hidden debt is encouraging, the more difficult problem lies with operational debt owed by LGFVs to financial institutions. People’s Bank of China Governor Pan Gongsheng reported that this category stood at 14.8 trillion yuan at the end of 2024. Unlike hidden government debt, these liabilities are not officially classified as government debt but still carry local government repayment responsibilities.
According to a veteran local debt researcher cited by Caixin, these operational debts fall into three categories: debt with no corresponding asset where cash flow is so poor the LGFV can only borrow to pay old debt; debt tied to non-cash-generating assets; and debt tied to cash-generating assets that can be rolled over on market terms.
The most difficult part of the problem lies with high-interest, non-standard loans. Many local governments pushed LGFVs to borrow through such instruments, which often involved opaque underlying assets. As a source close to policymakers told Caixin, “Currently, all LGFV operational debts that can be replaced have been replaced.” Banks are unlikely to take on compliance risks to restructure the remaining debt, as policy requires any swapped debt to be tied to a clear, financially sustainable project.
The Liquidity Squeeze Paradox
The resolution of hidden debt has created a paradoxical situation. While it lowered LGFVs’ borrowing costs, it transferred immense debt onto local governments’ official balance sheets, causing statutory debt to balloon from 40.7 trillion yuan at the end of 2023 to 54.8 trillion yuan two years later. Interest payments on this official debt are soaring, while land sales revenue — a crucial source of local fiscal revenue — has collapsed.
For LGFVs, the situation is equally dire. While principal can generally be rolled over, strict curbs on new financing have cut off their main source of cash for paying interest. A proposal to suspend interest payments and capitalize them was studied by government departments at the end of last year but was deemed to have too many drawbacks.
Some LGFVs are resorting to desperate measures. Several in Henan province have issued offshore bonds with double-digit real interest costs, while others in Shandong have issued non-standard products with rates above 6%.
Asset Revitalization: A New Strategy
With financing squeezed, local governments are turning to a new strategy: revitalizing state-owned resources, assets, and funds. Championed by provinces like Hubei and Hunan, the approach involves identifying and monetizing everything from data to reservoir silt to the space under bridges.
Hubei province, for example, identified 21.8 trillion yuan of such resources and revitalized over 300 billion yuan last year, as reported by Caixin Global and Sina Finance. However, this approach faces significant challenges. Many assets have ambiguous ownership and are difficult to value, as no mature market exists for them. This creates the risk of either selling state assets too cheaply or failing to attract investors.
China Chengxin International Credit Rating Co. warned that securitization and leveraging “can monetize future cash flow, postponing debt risk” rather than resolving it.
A Two-Track Debt Challenge
China’s local debt situation has evolved into a two-track problem. Track 1 — hidden debt — is on track for resolution by mid-2027, with the bond-swap program working effectively. Track 2 — LGFV operational debt — is more intractable, involving 14.8 trillion yuan in debt that is harder to restructure due to compliance issues and the presence of high-interest non-standard loans.
At a State Council Executive Meeting on May 9, 2026, officials emphasized that “the implementation of the package of debt resolution plans has achieved significant results” and called for continued focus on key areas, improved supporting policies, and enhanced local autonomous debt repayment capacity to ensure completion of debt resolution tasks on schedule.
He Daixin, Director of the Fiscal Research Office at the Chinese Academy of Social Sciences, noted: “Debt resolution is a means, development is the goal. Accelerating the establishment of a long-term government debt management mechanism that aligns with high-quality development will further enhance fiscal sustainability.”
What to Watch For
Several key questions remain unanswered. Will the central government provide additional support for LGFV operational debt resolution beyond the current 12 trillion yuan package? Can the asset revitalization strategy generate sufficient revenue to meaningfully address the debt burden? And what will happen to LGFVs that cannot achieve substantive transformation by the mid-2027 deadline?
As the mid-2027 deadline approaches, the transition from short-term crisis resolution to long-term governance of local debt will be one of the most critical economic stories to watch in China. The coming months will reveal whether Beijing’s dual-track approach can successfully navigate the country away from its reliance on off-balance-sheet borrowing without triggering the very financial instability it seeks to prevent.