Layoffs hit HK law firms amid deal drought; provinces go begging to Beijing

(Originally published March 14 in “What in the World“) What do you call a thousand lawyers at the bottom of Hong Kong’s Victoria Harbor?

A leading indicator of China’s gloomy economic outlook.

White-shoe corporate law firms in Hong Kong are laying off staff amid a deal drought from China. The Mainland was a cash cow for big firms when Chinese companies were busy tapping investors to buy their shares and bonds. But with China’s economy sliding ever-further into a deflationary funk, deals have dwindled and the Magic Circle of law firms—at least in Hong Kong—is getting a lot tighter. DLA Piper, Kirkland & Ellis, Mayer Brown, and Norton Rose Fulbright are just some of the international firms reported to have sent some folks down.

This is an even gloomier signal for Hong Kong, which has come to rely on its role as a conduit for capital into and out of China.

Officials from some of China’s most heavily indebted provincial governments used the annual leadership meetings in Beijing in the past week cap in hand looking for debt relief. According to the Financial Times, officials from Hebei, Liaoning and Tianjin city met with state bankers looking for ways to restructure or refinance their debts.

China’s local governments racked up 94 trillion yuan ($13 trillion) in debt, according to Goldman Sachs, to finance a decade of unbridled construction. They used property sales to service the debt, so when property prices began to slump, so did their ability to repay their debts. Moody’s estimates they have 3.2 trillion yuan in repayments this year. And property prices, even in prime markets like Shanghai, are still suffering. As a result, local governments have been cutting public services to avoid default, which isn’t helping China’s moribund economy.

Much of their debt is owed through local government financing vehicles (LGFVs). Despite efforts in 2015 by Beijing to get provincial governments to roll LGFV bonds over into provincial government bonds, the International Monetary Fund estimates LGFVs may have now racked up as much as 66 trillion yuan ($9.28 trillion), more than double what they had in 2017.

And while all that local government and LGFV debt isn’t technically owed by Beijing, it represents what bankers call a “contingent liability.” Lenders basically assumed when making the loans that Beijing backed the borrowers. If Beijing does back the borrowers rather than let those local governments and their LGFVs go broke, its own debts would jump from just over 20% of GDP to well over 120% of GDP, according to an estimate by Rhodium. Not only that, but Beijing would likely have to take over paying for vital public services now provided by local governments, including healthcare.

Beijing has responded by ordering several of these provinces to cancel big infrastructure projects and so keep them from racking up yet more debt in order to build them. The irony is that cutting back on government construction outlays will only starve the economy of investment and slow growth even further, increasing the likelihood that more provinces (and cash-strapped developers, for that matter) slide into default.

No one ever said digging your way out of debt was easy.