China Spawns Debt Market to Ease Burden on Local Governments

Updated on
  • China has 13 trillion yuan in public-private project filings
  • First Capital sees up to 50 billion yuan in ABS notes in 2017

China is promoting a new debt market for infrastructure projects where it wants private noteholders to take losses if developments fail.

Regulators gave the green light last month for public-private partnerships with at least two years of operations and stable cash flows to sell asset-backed securities. The nation is seeking to lure more private money into infrastructure projects, while limiting its responsibility for the debt needed to fund them.

China’s economic slowdown is hampering municipalities’ ability to support the 5.6 trillion yuan ($818 billion) of outstanding onshore notes sold by local government financing vehicles, which ballooned after the financial crisis when they used them to meet funding shortfalls. The notes offer an improvement over LGFV bonds because of cash-flow visibility, analysts said.

“The local government has a more explicit limited responsibility in these partnerships, while ABS, in theory, separates the risk from the issuer,” said Le Xia, a Hong Kong-based economist at Banco Bilbao Vizcaya Argentaria SA. “ABS could boost turnover and liquidity via a more diversified investor base.”

10,000 Projects

More than 10,000 PPP projects totaling 13 trillion yuan had been filed to the Finance Ministry as of Nov. 30, government data show. The ventures may issue as much as 50 billion yuan of new notes in 2017 because of strong regulatory support, said Wang Xuebin, executive director at the investment banking arm of First Capital Securities Co.

Fosun Group has agreed with the Chinese province of Zhejiang to invest 46.2 billion yuan in a high-speed train service. Billionaire founder Guo Guangchang said this month the company will make more public-private investments.

China’s government is trying to rein in financial risks while boosting spending on infrastructure projects to offset weakness in other parts of the economy, such as real estate. Borrowing by local governments has played a key role in keeping growth on track. The International Monetary Fund warned this week of risks from China’s rapid expansion of credit to stimulate its economy.

Analysts have mixed views as to how much responsibility local authorities will ultimately have in meeting payments on ABS issued by PPPs.

Upgraded LGFV Bonds

While local governments may not be legally obligated to make repayments on defaulted PPP-sponsored notes, their credit will be seen as similar to LGFV bonds, with “implicit support” from municipalities, according to Deng Rui, an investment officer at Changjiang Securities.

China had its first default on asset-backed securities in 2016, and defaults on local corporate notes more than quadrupled to at least 30, highlighting the increased risks of investing in Chinese debt.

“We can see these ABS for PPP as an upgraded version of LGFV bonds with comparatively better underlying assets and clear foreseeable incomes," said Zhang Xu, chief fixed income analyst at Everbright Securities. “If they were to offer higher market-oriented returns, investors would gradually turn their back on LGFV bonds.”

— With assistance by Yuling Yang, Jing Zhao, and Carrie Hong

(Adds Fosun’s investments in public-private partnerships in sixth paragraph.)
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