China’s Muni Bond Boom Sees Turnover Swell to Record $34 Billion

  • Notes attractive as possibility of default low: Moody’s says
  • Local governments to issue 6.2 trillion yuan debt this year

China’s municipal bond market is booming.

The extra yield that investors demand to hold local government debt versus the sovereign has fallen to a record low, while trading surged to an unprecedented 227 billion yuan ($34 billion) in June, according to latest available data. The notes are seen almost as safe as sovereign bonds, with no failures reported so far, while the number of corporate defaults has surged to all-time high this year.

The increased popularity of the municipal debt comes at an opportune time for China’s regional authorities, which are ramping up sales as they refinance existing borrowings and boost spending to help the economy. The governments are scheduled to issue about 6.2 trillion yuan of securities this year, compared with 3.8 trillion yuan in 2015.

“The surging market size and risk aversion are boosting demand for municipal bonds,” said Nicholas Zhu, a Beijing-based senior analyst at Moody’s Investors Service. “Their comparative value lies in the fact that the possibility of defaults is far lower than corporate bonds, at least in the near future.”

The Chinese government won’t intervene easily in cases of company non-payments, Finance Minister Lou Jiwei said on July 24, adding that public funds need to be involved only when risks involve the whole financial system or a region. The hands-off approach, relatively new in a nation that saw its first onshore failure only in 2014, is spreading to state-owned companies as well. Miner Sichuan Coal Industry Group reneged on one-year notes due in June, taking the number of defaults of publicly traded bonds to 17 this year from six in 2015.

Demand for safety has been driven also by an economy projected to expand at the slowest pace in 26 years, and by a currency set to weaken for the third year in a row. There are challenges from cooling manufacturing investment and a slowing property market, according to a July 25 note from HSBC Holdings Plc. China will continue a proactive fiscal policy in the second half of this year, the official Xinhua News Agency reported Tuesday, citing a statement after a Politburo meeting chaired by President Xi Jinping.

Shanghai is planning the nation’s first municipal bond issuance in a free-trade zone and on the Shanghai Stock Exchange this year, according to people familiar with the matter. The city’s finance bureau didn’t immediately reply to a fax seeking comment.

‘Relative Safety’

“The relative safety of local government bonds is attractive to long-term investors, as the weak growth environment is still in favor of the bond market,” said Li Qing, a Shanghai-based analyst at PICC Asset Management Co. “Sovereign bonds have been rallying for two years, so they’re not offering that much value to investors any longer.”

A Bloomberg China Sovereign Bond Index held steady in the April-June period, after advancing for nine quarters in a row. Local traders and analysts are most bullish on the securities issued by the government and policy banks, according to a Bloomberg survey conducted at the end of June.

Zhu at Moody’s warned against being too bullish. His company, while downgrading China’s credit rating outlook in March, cited a weakening of fiscal metrics and rising contingent liabilities. S&P Global Ratings, which made a similar revision four weeks later, said that while municipal notes are a more transparent way of raising money than the previous practice of using private financing vehicles, the concern is that authorities are still resorting to off-balance-sheet funding methods.

“Within municipal bonds, the performance of different regions will likely diverge gradually on account of economic fundamentals, financial positions including debt and SOE contingent liabilities,” Zhu said Tuesday.

Borrowing Surge

Borrowing by China’s regional authorities began to surge after the 2008 global financial crisis, when the government urged provinces to boost infrastructure spending. Regional authorities were at the time banned from selling bonds directly and so obtained funding via financing arms that were set up for specific projects.

Regulators started to allow the exchange of that high-cost debt into municipal notes last year. Local governments will convert about 5 trillion yuan of existing local debt into bonds this year, and issue 1.18 trillion yuan of new bonds.

To boost demand for such securities, Chinese authorities allow debt holders to pledge the notes to get central bank funds through various lending tools, including the Medium-term Lending Facility and Pledged Supplementary Lending. They can also be used as collateral to get treasury deposits and local government fiscal deposits. The yield premium on three-year municipal debt over the sovereign narrowed to 20 basis points on Tuesday, from a high of 48 last year. That’s the lowest since the nationwide market started to build up in May last year

“Allowing the munis to be used as collateral for central bank loans boosts liquidity in the secondary market and increases the attraction for investors,” said Zhang Tianshuo, an analyst at China Bond Rating Co.

— With assistance by Xize Kang, Jing Zhao, and Helen Sun

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