New bonds approved for old debt

NDRC's decision proves many local government financing vehicles have repayment problems

The National Development and Reform Commission, China's top economic planner, will allow bond swaps in an effort to avoid defaults in local government-created separate investment agencies.

In a statement posted on its website recently, the commission said as part of its latest debt-restructuring effort, it will let local government financing vehicles issue new bonds to replace old ones that may have matured but cannot be repaid due to lack of funds.

China has more than 10,000 LGFVs, created by local governments to fund the building of roads and other infrastructure.

Although bonds raised by them are counted as corporate debt, they are under direct or indirect government guarantee.

A large share of the debt stems from spending on highways, stadiums or public works as part of the stimulus program that helped China rebound quickly from the 2008 financial crisis.

But the rate of return on many of these projects is much lower than the interest rate promised when these debts were raised, triggering concerns about default.

Analysts said the commission's latest move proves there are repayment problems with many LGFVs and that it is a good decision, since the real problem for local governments is not whether they can repay their debts but when they can them.

According to the latest audit from the National Audit Office published on Jan 6, China's local government debt and contingent liabilities stood at 17.89 trillion yuan ($2.93 trillion) at the end of June. Of that, 2.49 trillion yuan of government direct debt, or 22.92 percent, was due in the second half of last year. Another 2.38 trillion yuan of debt, or 21.89 percent, is due this year.

"In general, China's government debt risks are under control, but there are potential risks in some places," the National Audit Office said when releasing its result.

The NDRC announcement did not mention how many LGFVs will be involved in the bond swaps but disclosed that 100 billion yuan of city investment bonds will be due this year.

The NDRC is conducting its own survey on corporate bonds and requiring LGFVs to ensure that the debt has corresponding repayment sources.

"Many LGFVs are ill-managed. Government assets are hastily pieced together for the sake of borrowing. They rarely think about repaying," said a manager from a credit-rating firm who declined to be identified.

Many market observers said the real risk of the local government debt is not in its size but in the "mismatch of maturity", meaning the repayment time arrives before LGFVs can receive cash flow from their invested projects.

An earlier report from the Urban China Initiative, a public-private think tank, said current city investment bonds are too small and have too short a maturity period. As such, they fail to cater to local governments' long-term financing of their infrastructure projects.

Although many city investment bonds have been issued and are popular among institutional investors, they are considered to be too small, accounting for only 3.5 percent of the total debt, according to UGI's report. In addition, 90 percent of these bonds have a maturity of less than 10 years while in the United States, 82 percent of municipal bonds have a maturity of more than 10 years.

To resume the construction projects halted due to a shortage of capital, the NDRC said it will allow LGFVs to issue new debt to repay their old debt as well as to fund unfinished projects.

These moves, market analysts said, will be good news for China's bond market this year.

"The potential for the development of a local government debt market in China is looking increasingly likely, given reforms announced by the central government in 2013," said Debra Roane, senior credit officer in the Global Sub-Sovereign Group of Moody's Investors Service.

She said she expects to see a greater divergence between LGFVs in credit quality: Some small and marginal LGFVs are likely to be the subject of default.

(China Daily Africa Weekly 01/10/2014 page21)