Yield Gap Doubles for Railroad in Spending Splurge: China Credit

Borrowing costs for China’s Ministry of Railways are surging this year amid concern the builder of the world’s biggest high-speed network will struggle to repay 1.8 trillion yuan ($275 billion) of debt.

The company sold 50 billion yuan of bonds this year, more than Indian Railway Finance Corp. and Russian Railways offered in 2010, and has more than 120 billion yuan of principal and interest payments due in 2011, according to data compiled by Bloomberg. The yield gap between its one-year notes and government debt more than doubled to 125 basis points on April 12 from 56 on Dec. 31, according to Chinabond data, the widest since September 2008 when Bloomberg started compiling the data.

The relative yield for bonds sold by the ministry, rated AAA domestically at the same level as the sovereign, which is ranked AA- by Standard & Poor’s, is wider than debt sold by billionaire Warren Buffett’s Berkshire Hathaway Inc (BRK/A).-controlled Burlington Northern Santa Fe that’s rated four levels lower at BBB+, according to data compiled by Bloomberg. China plans to spend 2.8 trillion yuan in the five years to 2015 on railway infrastructure to help sustain economic growth.

“The railway ministry cannot pay” its debt, said Zhao Jian, a professor at Beijing Jiaotong University, which can trace its origins to China’s School of Railway Management in 1909. “The central government will. This will happen within the near future, within the next five years,” he said.

Cutting Costs

China’s new railway chief ordered high-speed bullet trains yesterday to run slower to help lower fees, according to spokesman Wang Yongping. The ministry didn’t respond to telephone calls and a fax from Bloomberg seeking a comment.

The spread on the ministry’s 3.88 percent bonds due in 2020 over similar-maturity government notes reached 102 basis points, or 1.02 percentage point, on April 13, from a 66-basis point gap when the security began trading in September, Chinabond prices show. The 3.6 percent bonds due in 2020 sold by Burlington Northern Santa Fe yielded 80 basis points more than Treasuries on April 12, according to Trace, the bond price reporting system of the Financial Industry Regulatory Authority.

“Repayment is going to be an issue sometime down the road when the financial situation worsens further,” said Karen Li, the head of infrastructure research at JPMorgan Chase & Co. in Hong Kong. “They still have a lot of capex commitments over the next few years” as many projects are incomplete, she said.

Losing Steam

The nation’s new Rail Minister Sheng Guangzu pushed for the speed clampdown, said a China Daily report citing an interview with the minister. A speed cut will pare operating costs as a train running at 350 kph can use twice as much energy as ones going at 200 kph, the state-run newspaper said, citing Beijing Jiaotong’s Zhao.

Railway spending totaled 1.42 trillion yuan over the last two years, 33 percent more than was invested in the previous five, according to data compiled by Bloomberg. China plans to add as much as 30,000 kilometers of new track before 2015 to its 91,000-kilometers network, the People’s Daily reported April 13, citing Minister Sheng.

The ministry received 428.9 billion yuan in bank loans under China’s financial stimulus package in 2009 to buffer the nation against the impact of the financial crisis. Fiscal stimulus helped fuel inflation and the People’s Bank of China has raised interest rates four times since the third quarter to help drain excess liquidity from the financial system.

Default Swaps

The cost of five-year credit-default swaps protecting Chinese government bonds from default rose 1 basis point to 72 yesterday, down from this year’s high of 80 in January, according to data provider CMA.

Credit-default swaps insure debt against non-payment, and traders use them to speculate on credit quality. A drop signals improving perceptions of creditworthiness, while an increase suggests the opposite. London-based CMA is owned by CME Group Inc. and compiles prices from hedge funds and other clients.

The yuan, or renminbi, is forecast to gain the most this year among the currencies of the so-called BRIC economies, according to median forecasts in Bloomberg surveys.

The currency advanced yesterday to its strongest level in 17 years on speculation the central bank will tighten monetary policy further to tame inflation. The yuan gained 0.04 percent to end at 6.5315 per dollar in Shanghai, according to the China Foreign Exchange Trade System, after touching 6.5298, the strongest level since 1993.

Twelve-month non-deliverable forwards were little changed at 6.3790 per dollar in Hong Kong yesterday, reflecting bets the yuan will gain 2.4 percent, according to data compiled by Bloomberg.

Credit Line

The ministry has been promised a bank credit line of as much as 2 trillion yuan from domestic lenders, according to a recent bond prospectus. It borrowed 250 billion yuan from China Development Bank Corp, the state-owned policy lender, during the last five-year national economic plan which ended in 2010, according to the bank.

“They can borrow new loans to repay old loans, that’s how it’s operating,” said Zhao, adding that new rail services may not attract enough passengers. “It can’t go on like this.”

The 120 billion yuan in bond principal and interest payments due by the end of this year is more than 40 times its net income of 2.7 billion yuan in 2009, the latest data compiled by Bloomberg show. A railway construction fund set up by the government provides 50 billion yuan a year, according to Zhao.

China may be forced to form a company to absorb all of the ministry’s debt within the next five years to avert default, said Zhao. The ministry may be restructured with all its “good assets” placed into a company that will be sold to investors via an initial public offering, according to JPMorgan’s Li.

Chinese risk assessors such as China Chengxin International Credit Rating Co., Dagong Global Credit Rating Co. and China Lianhe Credit Rating Co. give the ministry their top AAA ranking.

“Their refinancing ability is very strong,” Zhang Jun, an analyst at China Chengxin, said from Beijing. “Liquidity may be weak, but the ministry depends on refinancing, not cash generated from the operations.”

--Henry Sanderson. Editors: Hugh Chow

To contact Bloomberg News staff on this story: Henry Sanderson in Beijing at 86-10-6649-7548 or hsanderson@bloomberg.net

To contact the editor responsible for this story: Will McSheehy at wmcsheehy@bloomberg.net

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