Fitch Urges Selected China LGFV Defaults For Mkt Discipline

     BEIJING (MNI) - The Chinese government should allow "selected" defaults on

bonds issued by local government financing vehicles (LGFVs) to promote better

scrutiny and prices by financial markets, Fitch Ratings said in a report Monday.

     The first defaults of LGFV bonds are becoming more likely, which could

trigger a re-pricing of LGFV debt by the market, Fitch Ratings predicted.

However, widespread LGFV defaults are unlikely, given the government is seen

having sufficient tools to avoid contagion to the broader LGFV market, Fitch

said. 

     No Chinese LGFV has defaulted to date on its publicly traded debt, Fitch

noted. 

     Under the 2014 Budget Law, LGFVs are no longer recognized as public-sector

liabilities and so are not officially eligible for government support. However,

the market has not adequately priced in the changed status, continuing to

believe that LGFVs will be bailed out rather than allowed to fail. 

     The need for greater market discipline is underlined by the fact LGFV debt

has grown strongly in past decade, Fitch said, estimating that CNY4 trillion, or

 5.4% of GDP, in LGFV bonds issued domestically remain outstanding. "It is

likely that this growth has involved at least pockets of excessive risk taking

and debt hiding," Fitch said.

     Selected LGFV defaults would lead to better risk discrimination and a

general re-pricing of LGFV bonds, Fitch said. The defaults may even accelerate

the development of a genuine municipal bond and loan market, it added. 

     After the first defaults, market liquidity for some LGFVs may dry up, at

least temporarily, especially for those vehicles with large amounts of

short-term debt that pose a refinancing risk, Fitch said. And access to foreign

borrowing could be more limited or more expensive for some LGFVs.

     Chinese authorities "are in a position to prevent systemic defaults," Fitch

stressed, given the government's "pervasive ownership and influence" over

domestic financial markets. While use of fiscal resources would be a last resort

because of efforts to eliminate the perception of implicit government

guarantees, they could be deployed to avoid market panic, if necessary, Fitch

said. 

--MNI Beijing Bureau; tel: +86 (10) 8532-5998; email: beijing@mni-news.com

--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com

--MNI Beijing Bureau; +86 (10) 8532-5998; email: vince.morkri@marketnews.com

[TOPICS: M$A$$$,M$Q$$$,MGQ$$$]