China to Let Foreign Rating Firms Score Local Government Bonds

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China plans to allow international ratings companies to publish their credit scores on local government securities as it seeks to attract more investors to the nation’s 30 trillion yuan ($4.8 trillion) domestic bond market.

Authorities in Asia’s biggest economy also promised more participation by foreign financial services companies in its local capital market, according to a joint statement from the China-U.S. strategic and economic dialog held June 23-24. The government will also establish an overall quota for foreign investment in the interbank bond market, rather than a country-by-country or institution-specific cap.

President Xi Jinping is allowing more foreign institutions into China’s domestic bond market as the nation pushes for its currency to be included in International Monetary Fund reserves this year. Overseas institutions held 735.2 billion yuan of onshore debt as of April 30, 2 percent of the 37.3 trillion yuan outstanding, official data show.

“China is accelerating the opening up of its domestic bond market because it seeks to make the yuan an international currency,” said Liu Dongliang, a senior analyst at China Merchants Bank Co. in Shanghai. “To allow foreign rating agencies to rate local government bonds would help draw more foreign investors.”

Opening China’s markets to the outside world has the potential to boost global holdings of the nation’s onshore bonds fourfold, to as much as $500 billion in five years, JPMorgan Chase & Co. estimates.

Onshore notes held by overseas institutions jumped 84 percent in the 16 months through April, during which time China’s bond market expanded 26 percent, data from the central bank and China Central Depository & Clearing Co. show. Foreign ownership of onshore stocks surged 87 percent to 644.4 billion yuan.

The government is seeking to find ways to stimulate growth without sharply increasing local government borrowing. The financing arms of regional authorities face a record amount of maturing notes this year. The Ministry of Finance has granted another 1 trillion yuan quota for a local-government debt swap, boosting the program to 2 trillion yuan.

Local government financial vehicles, or LGFVs, are being downgraded at an escalating rate as their financial position weakens amid the slowing economy. The credit scores of four so-called LGFVs were lowered in the last six months, according to China Merchants Securities Co., compared with one in the first six months of 2014 and seven for the full year.

Fiscal revenue in China, which includes both central and local governments, increased 5 percent in the January-May period, versus 8.8 percent in the same period of 2014, finance ministry data show.

“LGFVs’ credit profiles have worsened because of the sliding regional fiscal revenue,” said Sun Binbin, a bond analyst at China Merchants Securities in Shanghai.

LGFVs were set up in the thousands in China to fund infrastructure projects like roads and bridges after a 1994 law banned regional authorities from issuing bonds directly.

The interest rate on Erdos Dongsheng City Development & Investment Group Co.’s 1.5 billion yuan of notes due 2018 has soared to 20.1 percent since China Lianhe Credit Rating Co. cut its score to A+ from AA- on June 5, citing waning fiscal strength and increased borrowing. The securities yielded 8.1 percent before the decision.

The yield on Yijinhuoluoqi Hongtai City Construction Investment & Development Co.’s debentures due 2019 has risen 356 basis points to 10.47 percent since Pengyuan Credit Rating Co. cut its issuer rating to AA- from AA on May 27. Pengyuan said the downgrade was due to the possible dual impact of slowing coal and property industries on the local government’s income.

— With assistance by Judy Chen

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