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China’s credit investors are snapping up bonds issued in its most indebted provinces, encouraged by signs that Beijing will help local governments clean up a mountain of borrowings.
Local government financing vehicles (LGFVs) — investment companies that raise debt on behalf of local governments and build infrastructure projects for them — have been rushing to meet the renewed demand. Their monthly bond sales jumped in August to the second highest on record at Rmb640bn ($88bn), according to calculations by the Financial Times based on Wind data.
Enormous debts accumulated by China’s provinces and cities have become a pressing problem for policymakers, with Beijing recently dispatching experts to scrutinise the books of localities and deal with bloated balance sheets. Debt issued by LGFVs is estimated by the IMF to total Rmb66tn.
The surge in bond sales indicates onshore investors believe China will find ways to refinance and cut local government debt, as policymakers in Beijing work on a new model for LGFVs to drive economic growth.
“The laxer monetary conditions and the stronger expectation of proactive debt resolution are behind the recent interest in LGFV debt,” said Gary Ng, senior economist at Natixis in Hong Kong. “Government policy is always crucial for investing in China. It is now more important than ever.”
Bonds have been issued in August and September by LGFVs in the city of Tianjin near Beijing and in heavily indebted provinces, including northernmost Heilongjiang.
“There’s been a buying frenzy for LGFV bonds in recent months, and it has gone even crazier in September,” said a Shanghai-based high-yield bond investor in a private equity firm, who declined to be named. “Everyone now believes that this round of debt resolution of local governments will last for months, even years, and at least during this period of time, no LGFV bonds will default.”
Many bonds issued by indebted provinces such as Guizhou were on the brink of default last year, raising concern among credit investors with large holdings of LGFV bonds.
Although no LGFV bonds have ever defaulted on public markets, risk-averse investors showed little appetite for the debt in the first half of 2023. A spike in March to a record Rmb818bn in sales was caused by a need to refinance to avoid default as debts matured.
The demand for bonds from the financially riskiest local governments has pushed their coupon rate lower. LGFV bonds in the indebted provinces of Guangxi and Shandong are being issued at a coupon rate of 11 per cent, which is lower than usual for their risk profile.
The average coupon rate of all Tianjin LGFVs slid to 4 per cent in September from 7 per cent in June, data from Wind and calculations from the FT showed.
“Top picks by the current market would be LGFV bonds from Tianjin and Henan and Xi’an from the Shaanxi province,” a Shanghai-based bond trader at fund manager Western Leadbank said, adding that the bonds were attractive because they were believed to be in the first batch of regions to receive debt resolution plans.
Beijing is making one of its biggest efforts in years to tackle the LGFV debt problem. Under its initiative, as much as Rmb1.5tn of off-book debt could be swapped with debt underwritten by central or local governments with higher creditworthiness, according to financial media outlet Caixin. The China Securities Regulatory Commission has vowed repeatedly in recent months to prevent LGFV bond defaults.
Investors’ enthusiasm towards short-term LGFV bonds is expected to stay high over the short run, said Wang Ruoyang, analyst with China International Capital Corporation.
“At the end of the day, there is no asset on the market more attractive than LGFV bonds right now,” Wang said.