Bloomberg News

Ban on Muni Bond Sales Ends Amid Bad Debt Concern: China Credit

October 21, 2011

Oct. 21 (Bloomberg) -- China will allow some local governments to issue bonds independently, ending a 17-year ban that prompted authorities to set up thousands of companies which racked up $1.7 trillion of liabilities by the end of 2010.

The cities of Shanghai and Shenzhen, and the Zhejiang and Guangdong provinces will be able to sell debt themselves instead of going through the central government, according to a Finance Ministry statement yesterday. Nine of China’s 10 worst- performing corporate bonds in the past month were issued by local-government financing arms, with the 11.5 percent slide in Inner Mongolia Nailun Group’s 2018 notes leading declines. U.S. municipal debt dropped 0.2 percent in the same period, based on Bank of America Merrill Lynch’s Municipal Master Index.

Local governments in China set up the companies to fund the construction of roads, sewage plants and subways after they were barred from issuing bonds and obtaining bank loans directly under a 1994 budget law. A June report by the National Audit Office said there were more than 6,500 entities with debt of 10.7 trillion yuan ($1.7 trillion) at the end of last year, 42 percent of which would fall due in 2011 and 2012.

“This sends a strong signal that the central government is determined to find a solution to resolve local debt problems,” said Qu Hongbin, chief economist for Greater China at HSBC Holdings Plc in Hong Kong. “It also opens a door for widening long-term financing channels for local governments.”

Mongolia, Weinan

The nine local-government unit bonds that were among China’s worst-performing debt of the past month lost 6.6 percent on average, according to Shanghai Stock Exchange data compiled by Bloomberg. Weinan City Construction Investment and Development Ltd.’s 6 percent notes due in June 2017 were the worst performers after Inner Mongolia, losing 9.3 percent.

Local government financing units owed about 3.5 trillion yuan more than was reported by the state auditor, Moody’s Investors Service estimated in a July 5 report. China’s non- performing debt may account for as much as 12 percent of total credit, Moody’s said. As much as 30 percent of local government liabilities may go sour, Standard & Poor’s said in May.

“Most of the provinces have balance-sheet mismatch as they have borrowed short to fund long-term investment,” said Chi Lo, chief executive officer at HFT Investment Management (Hong Kong) Ltd. Even without central government guarantees, borrowing in the bond market is likely to prove cheaper than taking out bank loans, he said.

‘Hidden Risks’

China’s State Council will limit the amount that can be raised by local governments in the trial program and the Finance Ministry will handle payments for securities issued this year, the statement said, without including an explicit guarantee.

State-run fund Central Huijin Investment Ltd., which holds stakes in most of China’s financial institutions, said last week it would boost its holdings in the nation’s four biggest state- owned commercial banks after their shares slumped amid concern that bad debts will climb. Industrial & Commercial Bank of China Ltd. and China Construction Bank Corp., the world’s two biggest lenders by market value, have dropped 29 percent and 26 percent this year in Hong Kong.

“It’s undeniable that the lack of supervision and management of local government financing vehicles have created some hidden risks,” Liu Mingkang, China’s banking regulator said, according to a transcript of a speech posted on the body’s website yesterday.

Zhejiang, Shanghai

The State Council approved the Finance Ministry selling 200 billion yuan of bonds on behalf of local governments in March. Zhejiang has approval to sell 8 billion of debt yuan this year, the province’s fiscal department said in a faxed response to questions on Oct. 18. Shanghai was allocated 7.1 billion yuan, while Guangdong has 6.9 billion yuan, Caixin Magazine reported on its website on Oct. 10.

A total 22.9 billion yuan of notes are still to be sold in 2011 by the four local authorities included in the trial program, according to Caixin.

Officials at Guangdong province’s media office didn’t respond to faxed questions sent by Bloomberg News this month, while phone calls to the finance offices of Shenzhen and Shanghai weren’t answered. Xinhua News Agency reported in September that those cities and provinces had won permission to sell debt directly.

“Whether it’s worth buying these type of bonds will depend on their guarantees, be it tax revenue or cash flows from certain projects,” said Chen Qiwei, a senior bond trader at Shenzhen Development Bank Co. in Shanghai. “Certainly we are concerned about the issuer’s default risks.”

Default Swaps

The yield on the government’s 10-year bonds reached a three-year high of 4.13 percent on Aug. 30 and ended yesterday at 3.73 percent, Chinabond data show. The yuan was 0.05 percent stronger today at 6.3821 per dollar as of 12:08 p.m. in Shanghai, according to the China Foreign Exchange Trade System.

The cost of insuring Chinese sovereign bonds doubled this year as ratings companies highlighted the growing risk of loans to local-government financing vehicles and property developers. Five-year credit-default swaps on the notes were 148 basis points yesterday in New York, up 81 basis points in 2011, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.

The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.

The debt to be sold under the trial program will have maturities of three and five years, according to the ministry’s statement. The authorities involved can choose their own underwriters to arrange the sales.

Big Cities

Guangdong has the highest gross domestic product among China’s 23 provinces at 4.6 trillion yuan in 2010, according to data compiled by Bloomberg. Zhejiang’s GDP climbed 21 percent to 2.8 trillion yuan last year, while the city of Shanghai’s output was valued at 1.7 trillion yuan, the data show. The GDP of Shenzhen city was 951 billion yuan.

China’s overall GDP was $5.9 trillion last year, data collated by Bloomberg show.

“The trial program starts from places with relatively better fiscal conditions,” Fan Jianping, director of economic forecasting at China’s State Information Center, said by phone from Beijing yesterday. “Local governments will be able to gradually repay indirect borrowings, including bank loans, by raising funds from direct bond sales.”

Since March 2009, the Finance Ministry has issued bonds on behalf of cities and provinces collectively, repaying principal and interest. The ministry sold 17.6 billion yuan of three-year bonds this week at a yield of 3.67 percent on behalf of regional authorities, down from 4.01 percent at the last sale on Aug. 22. The yield on the central government’s three-year bonds fell three basis points to 3.48 percent yesterday, Chinabond data show.

“Issuing bonds doesn’t solve the fundamental problem but it does help the banks because now the onus is not just on them,” said Yao Wei, a Hong Kong-based economist at Societe Generale SA. “The risk will be spread to other investors.”

--Fion Li, Judy Chen and Henry Sanderson. With assistance from Belinda Cao in New York. Editors: James Regan, Emma O’Brien

To contact the reporters on this story: Fion Li in Hong Kong at; Judy Chen in Shanghai at; Henry Sanderson in Beijing at

To contact the editors responsible for this story: Sandy Hendry at; Shelley Smith at

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