Debt Resolution is Not Market Clearing: It Merely Moves the Landmine from the Desk to the Drawer

The market loves to misinterpret "no defaults" as "no risks". During a debt resolution cycle, the most common mistake the market makes is equating a lack of defaults with risk clearing. This mistake is captivating because it allows everyone to sleep better. Fund managers do not have to explain net asset value fluctuations, traders no longer need to stare at the trading volume of specific "internet-famous" regions, and investment committees do not have to repeatedly ask the same question: Will this thing actually blow up?

Just because a building hasn't collapsed doesn't mean its foundation has improved. Sometimes, the cracks were just painted over overnight, and when the residents wake up to clean walls, they temporarily forget about the groaning pillars downstairs.

In the past, Urban Construction Investment Bonds (LGFV bonds or "Chengtou" bonds) were exactly this type of asset. Nominally, they were corporate bonds, but they traded with the scent of local government credit. Buyers claimed they were looking at the issuer's qualifications, regional financial strength, land revenues, and platform hierarchy, but what they were truly watching for was whether the invisible hand would intervene.

On July 24, 2023, the Political Bureau of the Central Committee proposed to "effectively prevent and resolve local debt risks, and formulate and implement a comprehensive debt resolution plan". This phrase quickly changed the temperature of the LGFV bond market. Special refinancing bonds were restarted, financial debt resolution advanced, banks rolled over loans and lowered interest rates, some regions began unified borrowing and repayment, and yields in high-risk regions dropped accordingly.

The market suddenly felt that while the landmine was still there, it most likely wouldn't detonate in their own hands tonight.

This reassurance is subtle. It's not the peace of mind that comes from improving fundamentals; it's more like hearing a guard on duty in the next room at night. With an extra guard at the door, the people inside sleep a little more soundly.

In November 2024, the 12th Session of the Standing Committee of the 14th National People's Congress approved an increase of 6 trillion yuan in the local government debt limit to replace existing hidden debts. Relevant officials from the Ministry of Finance introduced that, starting in 2024, 800 billion yuan will be allocated annually from newly added local government special bonds for five consecutive years specifically for debt resolution, cumulatively replacing 4 trillion yuan of hidden debt. Adding the 2 trillion yuan in hidden debts from shantytown renovations due in 2029 and beyond—which will still be repaid according to original contracts—the total hidden debt local governments need to digest will drop from 14.3 trillion yuan to 2.3 trillion yuan.

When the market read these numbers, the first reaction was that the safety cushion had thickened.

This reaction isn't wrong. The problem is that a safety cushion is not cash flow. Narrowing spreads do not mean the assets have become clean. It merely shows that the market has begun to believe someone will help mop the floor.

II. What is True Clearing vs. Fake Clearing?

True clearing is cruel. Bad assets are recognized, losses are distributed, inefficient entities exit, and prices return to levels supported by cash flow.

Fake clearing is much gentler. Short-term repayment pressures disappear, debt maturities are extended, coupon rates are suppressed, and risks are moved from the desk into the drawer. Once the drawer is closed, the room looks tidy, and the debts are given more respectable names.

The current round of debt resolution is closer to the latter.

When Ministry of Finance officials introduced this round of debt replacement in November 2024, they stated that this policy represented a "fundamental shift" in the approach to debt resolution, moving from emergency response to proactive resolution, from point-by-point mine clearance to holistic risk elimination, and pushing the management of hidden and statutory debts toward greater standardization and transparency.

This is an important change. It shifts the pressures previously hidden in financing vehicles, non-standard assets, arrears, and various gray financing chains into a more explicit government debt framework.

However, it is still not "clearing" in the market sense.

• Many underlying assets have not been sold.
• Many inefficient projects have not been shut down.
• The operating cash flow of many platforms has not suddenly become sufficient to cover principal and interest.
• Research in 2025 showed that while LGFV debt structures have improved, with bank loan proportions increasing and bonds/non-standard assets decreasing, the total volume of interest-bearing LGFV debt remains high.
• Lower financing costs bring a marginal easing of interest payment pressures, but replacing high-cost legacy debt with new low-cost debt takes time.

This is where debt resolution is most easily misread. It has dealt with maturities, interest rates, and some liquidity pressures. It has not yet fully resolved asset quality.

True clearing writes off bad debts. Fake clearing turns bad debts into a long vacation.

III. Why Did LGFV Bonds Rise First? The Market is Buying Policy Time, Not Credit

The reason LGFV bonds rose first is no mystery.

Investors believe that short-term tail risks have been suppressed by policy. Many are not buying into the idea that these platforms have organically regenerated cash flows; they are buying the rearranged timeline. Debts faced this year might be swapped for longer maturities; high-interest non-standard assets and high-coupon bonds might be replaced by low-cost funds; the default "bang" the market feared most might be pre-emptively subdued in the policy ward.

In 2024, LGFV bond issuance rates dropped significantly. Relevant research noted that debt resolution policies lowered tail risk expectations, and coupled with an "asset famine," yields on weaker, lower-rated LGFV bonds actually saw a sharper decline. This phenomenon looks like credit improvement, but it is actually the market repricing default probabilities based on policy.

Yet, simultaneously, another set of data warns the market not to get too intoxicated. Net financing for LGFV bonds dropped drastically in the first three quarters of 2024, with net outflows for two consecutive quarters. The narrow ratio of "borrowing new to repay old" exceeded 95%, with the overall level reaching 93.08% for the first three quarters. In some provinces, this ratio even reached 100%.

This is not an expansion story. It is a survival story.

The market isn't buying LGFV growth. The market is betting on short-term survival.

In a debt-resolution rally, LGFV bonds sometimes act less like bonds and more like a visitor's pass to a policy hospital ward. Investors don't truly believe the patient can run a marathon next week; they just believe the hospital won't pull the plug tonight.

IV. How the Stock Market Prices Debt Resolution: Not All "Local Fiscal Recovery" is Bullish

For equities, the impact of debt resolution cannot be summarized with a simple "bullish" label. Its transmission paths to banks, construction, local state-owned enterprises (SOEs), real estate, and consumer sectors are all different.

• For Banks: Debt resolution can lower the tail risks of LGFV-related loans. Ministry of Finance officials mentioned in November 2024 that the replacement policy could improve financial asset quality and enhance credit issuance capacity, benefiting the real economy. This is crucial for bank stocks because it means some hard-to-value local platform risks can be partially absorbed by longer-term, lower-coupon, and more explicit debt arrangements.
• For Construction, Infrastructure, and Local SOEs: Debt resolution can alleviate arrears and cash flow pressures. However, it doesn't necessarily herald a new wave of local investment impulses. Lianhe Ratings' analysis of 2024 LGFV annual reports showed that the growth rate of urban construction assets, self-operated assets, and equity fund investments by LGFVs slowed significantly compared to 2022. Urban construction assets remain the primary component, but growth has dropped to a low level, indicating that local investment and financing functions remain constrained.
• For Consumption and Real Estate: Debt resolution only improves local governments' payment capacity and confidence. It cannot directly create resident income or repair housing demand. Due to the real estate downturn and sluggish land market in 2024, government fund revenues in most provinces and cities dropped, with Jiangsu, Zhejiang, Guangdong, and Hunan seeing declines of over 20%.

These numbers remind the market that local fiscal water levels haven't truly returned.

Therefore, stock pricing cannot crudely interpret debt resolution as "local fiscal recovery". Some sectors get a reduction in bad debt tail risks, some get improved collections, and some merely get a breather in expectations.

Debt resolution is not a starting gun for a bull market. It's more like applying a tourniquet to the balance sheet. Whether it can walk after the bleeding stops depends on whether the muscles are still there.

V. Real Estate and Land Finance: The Most Awkward Shadows of Debt Resolution

Behind the local debt problem lies the receding tide of land finance.

In the past, many LGFV assets, cash flows, and debt repayment arrangements were tied to land sales, infrastructure expansion, and platform financing. When this machine ran smoothly, land could be sold, projects could roll over, platforms could borrow, and fiscal budgets could circulate. After the real estate downturn, government fund revenues dropped, LGFV asset-side collections slowed, yet the liability side still had to pay interest as usual.

Data from 2024 has already laid this bare. Lianhe Ratings' tracking analysis noted that due to the real estate downturn and a sluggish land market, government fund revenues in most of the 31 provinces and municipalities nationwide declined in 2024. This isn't a problem isolated to weaker regions; it's a shift in the underlying water source of local finances.

This makes debt resolution awkward. The liability side can be swapped, but the cash flow side cannot be instantly restored. Existing LGFV debt maturities can be extended, but the shortfall in land revenue won't automatically disappear just because the timeline is stretched.

The 2025 Government Work Report proposed intensifying urban village and dilapidated housing renovations, driving the real estate market to stop declining and stabilize, perfecting and implementing the comprehensive debt resolution plan, and dynamically adjusting the list of high-risk debt regions. Looking at these policies together shows that officials clearly understand that debt resolution, real estate, and local finance are not three isolated issues.

Land finance is not a broken ATM that will dispense cash again if you change the plug. It's more like a riverbed after the tide has gone out; the watermarks are still there, but the boat is already stranded.

VI. Regional Divergence: Debt Resolution Doesn't Wash All Provinces into One Color

The biggest pricing shift in this round of debt resolution is that not all LGFVs are safe.

What the market truly cares about now is which regions receive more policy resources, which regions still have fundamentals, and which regions are merely being temporarily fished out of the water.

At the end of 2024, debt ratios in key provinces and cities generally rose. Statistics from Lianhe Ratings show that debt ratios in Guizhou, Chongqing, Jilin, Yunnan, and Tianjin saw large increases, all rising by more than 20 percentage points compared to the end of 2023. Looking at broad debt ratios, except for Tianjin and Guangxi, the broad debt ratios in other key provinces and cities continued to rise. This shows that while debt resolution has achieved phased results, the debt pressure has not disappeared from the roots.

The LGFV market is also still diverging. Research by China Chengxin International (CCXI) noted that the comprehensive debt resolution package achieved phased results—local debt growth slowed, structures were optimized, costs were reduced, and LGFV bond sentiment was boosted. At the same time, debt resolution pressures are transmitting to fiscal budgets, interest payment pressures are rising, and the phenomenon of "capitalizing interest" still warrants attention.

• For strong fiscal regions, debt resolution looks more like cost reduction.
• For medium-pressure regions, debt resolution looks more like buying time.
• For weak fiscal regions, debt resolution is primarily about maintaining non-default status.

These three types of assets should not be washed into the same color by a single spread curve.

Debt resolution is not bleach. It cannot wash away the base color of regional fundamentals.

VII. True Observation Indicators: Don't Just Look at Spreads, Look at Cash Flow

During a debt resolution cycle, investors easily fixate on spreads. Spreads are undoubtedly important; they reflect the market's pricing of tail risk and the crowdedness born from an "asset famine". But a spread is not an autopsy report; it's just the EKG monitor outside the hospital room.

What should truly be monitored is local finance and platform cash flow.

• The proportion of tax revenue in the local general public budget reflects revenue quality.
• The decline in government fund revenues reflects the water level of land finance.
• LGFV operating cash flows and receivable collection speeds indicate whether the platform is genuinely generating blood.
• Interest-bearing debt growth rates, and the proportions of bank loans, bonds, and non-standard assets, show whether the debt structure is stabilizing.
• The ratio of borrowing new to repay old, the quality of platform transition revenues, regional land transactions, and industrial tax bases are the true measures for judging the effectiveness of debt resolution.

Relevant research in 2025 showed that as of the end of March 2025, total interest-bearing debt for LGFV platforms remained high. Structural shifts occurred among bank loans, bonds, and non-standard assets, with bank loan proportions rising while bonds and non-standard assets fell. Following the decline in financing costs, LGFV interest payment pressures eased marginally, but replacing legacy high-cost debt with new low-cost debt takes time.

This means that part of the recovery the market sees now is real. The drop in interest costs is real, the easing of non-standard asset pressure is real, and the structural improvement in financing for some platforms is also real. The problem is that the debt principal is still there, local finances remain in a tight balance, and platform transformation cannot be achieved simply by changing a few business reporting metrics.

In a debt resolution cycle, spreads are just sentiment; cash flow is the autopsy report.

VIII. Conclusion: Fake Clearing Has Value, But Don't Mistake Painkillers for Surgery

Fake clearing is not without value.

It buys time.

• For local governments, time can be used to alleviate short-term repayment pressures.
• For financial institutions, time can slow the deterioration of asset quality.
• For the market, time prevents the spread of tail risks.
• For platforms, time might buy a window for true transformation.

Ministry of Finance officials stated in November 2024 that this round of replacements solves the local governments' "urgent needs," relieving current debt resolution pressures and reducing interest expenses, saving roughly 600 billion yuan in interest over five years. At the same time, the replacement policy frees up resources that would have been used for debt resolution, redirecting them toward promoting development and improving livelihoods.

These effects cannot be underestimated. They are vital for stabilizing expectations and preventing regional risks from spilling over.

However, time itself is not the answer. Time merely allows the real answers an opportunity to emerge. The true answers still lie hidden within the tax base, land revenues, industrial capacity, platform transformation, and cash flows.

The Ministry of Finance officials also emphasized that while resolving the risks of existing local government debt, they must resolutely curb the addition of new hidden debts and maintain a "zero-tolerance" high-pressure regulatory stance.

The implication of this statement is clear. The policy is not meant to allow local governments to disorderly expand their balance sheets again, but to place already inflated debts into a more transparent, lower-cost, and longer-term framework.

During a debt resolution cycle, the market is easily deceived by a certain quietness. The absence of thunder does not mean the sky has cleared. It might just be that the landmine was buried deeper, its fuse cut shorter, and a few more guards were stationed nearby.

True clearing lets bad assets die.
Fake clearing lets bad assets live longer.

Both of these things might have value, but they are not the same thing.