China’s regional bond repayment bill has doubled in the year since former Premier Wen Jiabao told parliament he would curb the debt to “appropriate” levels.
About 82.5 billion yuan ($13.4 billion) of paper sold by local government financing vehicles comes due in the three months ended April 30, or 37 percent of this year’s total of 224.84 billion yuan, according to data from China Chengxin International Credit Rating Co., Moody’s Investors Service’s joint venture in China. That’s 27.5 billion yuan of maturities a month, up from 13 billion yuan a year earlier.
Wen’s successor Premier Li Keqiang maintained the nation’s 7.5 percent economic growth target in his first address to the annual meeting of lawmakers today, highlighting risks in finance and fiscal areas. Total liabilities in China have swelled to 215 percent of gross domestic product, according to the Chinese Academy of Social Sciences, surpassing levels seen in Japan and Thailand before financial crises in those nations.
“Borrowing new debt to repay the old is still among the most commonly used tactics for LGFVs, so the market needs to pay close attention to the refinancing risk,” said Zhang Yingjie, Beijing-based deputy general manager in Chengxin’s research department. “Risks on LGFV bonds are rising.”
Local governments, which are barred from selling debt directly, have set up thousands of companies known as LGFVs to raise funds to build subways, highways and sewage works. Their liabilities rose to 17.9 trillion yuan as of June 2013 from 10.7 trillion yuan at the end of 2010, according to National Audit Office data.
Li told the National People’s Congress that China will develop a regulated regional borrowing mechanism and include local liabilities in its fiscal budget. The Ministry of Finance said it will sell 400 billion yuan of debt this year on behalf of regions, 50 billion yuan more than last year. It will maintain municipal-bond market trials, targeting the ultimate removal of the government financing function from LGFVs.
“A 7.5 percent target for China’s GDP growth in 2014 signals that the government is unwilling to push painful reforms at the expense of lower growth,” said Tom Orlik, a Beijing-based Bloomberg economist. “The promise of 7 million starts in affordable housing, up from 6.6 million in 2013 is one example of the government’s capacity to bolster growth through pushing massive public spending projects.”
Fiscal spending and revenue both grew faster than target last year at 10.9 percent and 10.1 percent, respectively, helping the budget deficit meet its 1.2 trillion yuan target. China plans to run a shortfall of 1.35 trillion yuan in 2014, the MOF said, amounting to 2.1 percent of GDP. Fiscal spending is targeted to rise 9.5 percent and revenue 8 percent.
“We expect an increase in issuance of municipal bonds in 2014,” said Becky Liu, Hong Kong-based Greater China rate strategist at Standard Chartered Plc.
China began a trial program in 2011 to let some local governments sell bonds directly and widened the pilot in June, allowing Shandong and Jiangsu provinces to join Zhejiang and Guangdong plus the cities of Shanghai and Shenzhen. A proposal that would have allowed authorities to sell notes within an approved quota was dropped from a revision of the budget law in June 2012.
Sales of LGFV bonds in February climbed 32 percent from January to more than 40 billion yuan as of Feb. 26, the highest monthly issuance since November. A Moody’s report in November said most such firms have weak credit profiles, and that only 53 percent of the 388 companies it surveyed in June had enough cash to cover estimated payments and interest last year without refinancing.
“The risk in LGFV bonds lies in the financial status and refinancing ability of the regions the vehicles are located in,” said Chengxin’s Zhang. “Investors should show caution over regions which have the worst leverage ratios.”
China’s benchmark money-market rate is falling. The seven-day repurchase rate plunged 275 basis points this year to a nine-month low of 2.78 percent on March 3, according to a fixing published by the National Interbank Funding Center. The rate rebounded yesterday to 3.53 percent and advanced to 3.81 percent today after the central bank drained 85 billion yuan from the financial system via sales of repurchase agreements.
The rate on Liaoning LGFV Jinzhou Economic Technology Zone Development Group Co.’s seven-year sinkable bonds fell from 9.1 percent in a sale in January to 8.38 percent at another issuance in late February, data compiled by Bloomberg showed.
Debt sold last month achieved even lower borrowing costs. Xiantao City Construction Investment Development Co., based in Hubei province, sold seven-year debt at 8.15 percent on Feb. 21, while Fengcheng City Construction Investment Co., located in Jiangxi, issued similar-maturity notes at 7.5 percent on Feb. 26.
The premium of five-year AA bonds, the most common grade for LGFVs, over top-rated corporate notes widened to 148 basis points on Feb. 12, the most since April 2012, before narrowing to 141 yesterday. The yield on China’s 10-year sovereign debt has declined to 4.505 percent since climbing to an unprecedented 4.72 percent on Nov. 20. The yuan, which fell a record 1.4 percent in February, rose 0.08 percent to 6.1382 per dollar in Shanghai today.
“As market rates tumbled, and yields slid in late February, sales rebounded,” said Li Qing, an analyst at Guotai Junan Securities Co. “The yields for LGFV bonds seem to be at a bottom.”
The People’s Bank of China has singled out LGFVs, industries with overcapacity and property developers as the three types of debt that face the highest default risks, according to its fourth-quarter policy report.
Shanghai Chaori Solar Energy Science & Technology Co., a maker of cells to convert sunlight into power, yesterday said it may not be able to make an 89.8 million yuan interest payment in full by the March 7 deadline, in what may be the first default of an onshore bond. A failure would highlight the strain in China’s financial system after a trust product issued by China Credit Trust Co. was bailed out in January.
“This is the first onshore default,” said Yang Kun, a bond analyst at Guotai Junan. “It shows the regulators’ attitude toward default has changed and they’re silently permitting defaults. There will definitely be more bond defaults to come, probably private and small companies.”