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 The increased borrowing for an economy already swimming in debt adds
to concerns about growing bubbles in certain major asset classes,
such as real estate and commodities, and a bond market seeing a rise
in corporate defaults.
Economists say increasing public sector investment – most of it
financed locally with debt – is behind improvements in China's
economy. First-quarter GDP rose at the weakest pace in seven years,
but other data suggested growth was picking up in March.
"With new infrastructure projects effectively all funded by debt and
more consumer mortgages, the leverage problem and risks on the
financial sector are rising," Credit Suisse analysts wrote in a
research report.
Local government financing vehicles (LGFVs), which Chinese cities
use to circumvent official spending limits, raised at least 538
billion yuan ($83 billion) in bonds in the first quarter, up 178
percent from a year earlier and the highest quarterly issuance since
June 2014, Everbright Securities said, quoting figures from
privately held financial data provider WIND.
Issuance in March alone was a monthly record of 287 billion yuan
($44.3 billion).
China's planning agency, the National Development and Reform
Commission, declined to comment on the sharp rise in LGFV issuance.
Most of the LGFV debt in the first quarter was made up of so-called
enterprise bonds, which the NDRC oversees.
Beijing had been trying to move LGFV debt on to municipal balance
sheets via the 2014 creation of a municipal bond market. But
policymakers retreated from this in the middle of 2015, easing
borrowing restrictions as economic growth stumbled.
Consequently, LGFV issuance in the first quarter of 2016 was nearly
60 percent as large as the municipal bond issuance meant to replace
it, up from just 37 percent in the fourth quarter of 2015, central
clearinghouse and brokerage data shows.
"In the second half of last year, the government raised the
percentage of project financing that can be funded with debt," said
Yang Zhao, chief China economist at Nomura in Hong Kong, helping
spark the flurry of LGFV deals.
"If they continue on, the debt-to-GDP ratio could actually go up
quite rapidly. I don't think the policy is sustainable, and you'll
see policymakers slow down the pace of (credit) easing in a quarter
or two."
Much of China's huge debt overhang from the global financial crisis
was generated by these same LGFVs which – in addition to funding
legitimate infrastructure – became infamous for building ghost
cities and roads-to-nowhere as local officials took advantage of
crisis level ultra-low borrowing rates.
This helped push China's debt-to-GDP ratio to more than 240 percent
at the end of 2015, estimates from the Bank for International
Settlements show.
FLIGHT TO SAFETY
Despite the concerns flagged by analysts, LGFV bonds are proving
relatively attractive to investors as a rising number of corporate
defaults - including by some non-LGFV state firms with weaker
backing - undermines confidence in company debt.
Defaults have been on the rise this year, including in industries,
such as steel, that suffer from over capacity.
"Managers are increasingly concerned about corporate bond credit
quality and so they're getting back into government or
quasi-government debt," said a director at a foreign buy-side money
manager in Shanghai.
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Yields on three-year AA-rated LGFV bonds, which in mid-2015 were
higher than regular enterprise bonds, now trade 30 basis points
cheaper. Enterprise debt is a category of the market mainly used by
state affiliated borrowers.
"It's easier to raise money right now, after all LGFV bonds are
basically half government bonds," says Li Xiangdong at the
Qinhuangdao Development Investment Holding Group Co Ltd, an LGFV
owned by the coal port city of Qinhuangdao in China's struggling
Northeast. "Default risks are low."
ROADS TO NOWHERE?
The latest local government debt binge has raised funds for a
variety of projects from parking lots to renovations of tourist
attractions in obscure regions.
Most new issues posted in April on the website of China's main bond
clearinghouse funded pipelines, or water treatment systems and, more
worryingly, housing projects.
"There are some parts of the country where (housing) inventories
have come down enough for new construction to make sense," Rosealea
Yao of Gavekal Dragonomics wrote in a research note.
"But there are also parts of China where inventories are still
rising - and construction is nonetheless picking up, probably
because of state-directed spending."
In southwestern Guizhou, one of China's poorest provinces, Jinsha
County Construction and Investment Co Ltd, an LGFV, sold 800 million
yuan of seven-year bonds on April 27.
Among other projects, the funds will help finance a 1.2 billion yuan
athletic culture park, including a hotel, shopping street, and a
103,000 sq meters (1.1 mln sq feet) stadium and gym complex -
roughly twice the size of Europe's largest soccer stadium that is
home to Barcelona football club.
The bonds carry an AA rating, the third highest credit rating, with
the rater citing strong local government support as part of its
rationale, even though Jinsha County Construction's ratio of
operating income before line items over interest payments due has
fallen sharply. In 2012 it was 57 times interest payments due and in
2014 it was less than two times.
Calls to the head of Jinsha County Construction finance department
went unanswered.
After the wave of LGFV deals, rising yields suggest some investors
are starting to grow cautious amid a broader selloff in Chinese
bonds. About $15 billion in debt issuance has been delayed in April,
including by several LGFVs.
(Additional reporting by Ina Zhou from IFR and the Shanghai
Newsroom:; Editing by Nachum Kaplan and Neil Fullick)
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