Beijing Debut Opens Global Bond Market for Regions

China’s local governments are seeking global investors to cut costs on 17.9 trillion yuan ($2.9 trillion) in debt as the property market weakens, yields surge and economic growth cools to the slowest in 24 years.

Beijing Infrastructure Investment Co., which is building China’s biggest subway in the capital, sold 1.2 billion yuan of three-year securities at 3.75 percent in Hong Kong on June 19 and $300 million of five-year dollar bonds at 3.625 percent in March. That’s lower than the 5.06 percent offered on one-year onshore debt in May. Moody’s Investors Service said several local-government financing vehicles had inquired about overseas offerings and are being encouraged by regional authorities.

“More LGFVs are likely to follow suit for cheaper costs and flexibility if they are capable of issuing overseas bonds,” Ivan Chung, Hong Kong-based senior vice president of Greater China credit research and analysis at Moody’s, said in a June 23 phone interview. “There’s a huge difference in onshore and offshore funding expenses. Also, the strong demand and limited supply of yuan products abroad is favorable.”

LGFVs need to repay an unprecedented 214 billion yuan of bonds in 2014, according to latest China Chengxin International Credit Rating Co. estimates, after accelerating spending on roads, bridges and subways following the 2008 global financial crisis. Five-year borrowing costs for AA rated companies, the most common grading for such issuers, rose 69 basis points from a year earlier to 6.54 percent yesterday, compared with 3.83 percent for the sovereign.

Debt Plan

Regional governments in the world’s second-largest economy set up more than 10,000 financing units to bankroll construction projects after they were stopped from directly issuing bonds under a 1994 budget law. They are responsible for about 80 percent of spending while getting only 40 percent of tax revenue, the result of a 1994 tax-sharing system, according to World Bank data.

Beijing Infrastructure established a $2 billion medium-term note plan on June 13, according to a statement posted on its website yesterday. The Dim Sum bonds issued by unit Eastern Creation II Investment Holdings Ltd. and the dollar notes sold by Eastern Creation Investment Holdings Ltd. were both rated A2 by Moody’s, the sixth-highest of 10 investment grades. Three calls to the parent went unanswered yesterday. The company’s net income in 2013 was 5.31 billion yuan and total assets were 327 billion yuan as of the end of last year, according to its website.

GDP Impact

China’s economy will expand 7.3 percent this year, the slowest pace since 1990, according to the median estimate in a Bloomberg survey. Home sales dropped 10 percent in the first five months of 2014, official data show. Land deals tumbled 49 percent in May from a year earlier, according to SouFun Holdings Ltd., which owns the country’s biggest real-estate website. Moody’s cut its credit outlook for Chinese developers to negative from stable on May 21.

A 10 percent drop in property sales and building construction would lower gross domestic product growth to 5-6 percent from 7-7.5 percent, Tom Byrne, senior vice president at Moody’s, said at a June 19 conference in Shanghai. This real-estate downturn will be more prolonged compared with recent corrections, he added.

Property-related taxes and land sales accounted for 52 percent of local government revenue last year, according to estimates by Chengxin, a Moody’s joint venture. National fiscal revenue growth slowed to 8.8 percent in the first five months of 2014, compared with 9.3 percent in the January-April period, according to latest year-to-date data from the Ministry of Finance.

Main Risk

“A weakening property market will be the main risk for local government debt,” said Yan Wentao, assistant to the head of Chengxin’s sub-sovereign rating department. “The slowdown in revenue growth looks ominous. Lower land prices will affect LGFVs’ balance sheets and local governments’ land-sales revenue, which will affect their ability to repay debt.”

China will strengthen financial risk monitoring, and “proactively” lower LGFV risks, People’s Bank of China Deputy Governor Liu Shiyu said yesterday in a report to the Standing Committee of the National People’s Congress, the nation’s top legislature.

Total liabilities of local governments rose to 17.9 trillion yuan as of June 2013 from 10.7 trillion yuan at the end of 2010, the National Audit Office estimated last year after a nationwide survey. Outstanding debt in nine provinces and nine cities grew 3.79 percent from the end of June last year through this March, 7 percentage points slower than the average pace in the first half of 2013, according to a report posted on the National Audit Office’s website.

Record Issuance

Sales of so-called chengtou notes quadrupled from a year ago to 183.8 billion yuan in April, according to Chinabond data.

The National Development and Reform Commission will work to prevent regional defaults, according to a statement posted on the agency’s website on Dec. 31. The vehicles will be allowed to sell bonds at lower costs to refinance more expensive borrowings, and the NDRC can approve new debt to finish projects short of funding, according to the statement.

The financial burden for local governments may become increasingly unsustainable, given the vast scale of works and the governments’ already-high indebtedness, according to a June 11 report written by Standard & Poor’s Ratings Services analysts led by Gloria Lu.

Bonds, Yuan

The yield on China’s 10-year sovereign debt rose 45 basis points in the past year to 4.05 percent yesterday, according to ChinaBond data. The yuan, which has declined 2.9 percent in Asia’s worst performance this year, fell 0.02 percent today to 6.2330 per dollar as of 11:35 a.m. in Shanghai.

“Not every LGFV meets the criteria to sell bonds overseas,” said Moody’s Chung. Only those with a transparent structure and strong financial support from the local government can attract overseas investors, and that too only if they have overseas units and businesses that can help transfer the money back, he said.

China started to let the governments of 10 provinces and municipalities repay their bonds themselves this year in an expansion of a municipal debt trial. A 2014-2020 urbanization plan looks to set up a transparent financing mechanism for city construction that will allow local governments to sell municipal bonds directly to investors.

The government of Guangdong province sold 5.92 billion yuan of five-year bonds at 3.84 percent, 4.44 billion yuan of seven-year bonds at 3.97 percent, and the same amount of 10-year bonds at 4.05 percent yesterday, according to a statement on the website of China Central Depository & Clearing Co.

“The number of LGFVs qualified for overseas financing may be quite limited,” said Wang Ming, marketing director at Shanghai Yaozhi Asset Management LLP. “But before China sets up a new financing system for local governments, the authorities will make the existing model continue to work so as to prevent any liquidity shocks that could have a wider impact.”

— With assistance by Helen Sun

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