MNI: Some China LGFVs Get Red Cards In Implicit Debt Cleanup

China is dialing back implicit, or off-book, municipal debt using tools that advisors tell MNI should give investors more confidence even as a squeeze on new issuance raises concerns of repayment risks from some local government financing vehicles.

Stock exchanges in China are tightening new bond issuance policies for LGFVs to gradually lower their leverage overall and nibble at an estimated CNY40 trillion of implicit municipal off-balance-sheet debts, including non-standard financing not linked to bonds.

LGFVs grouped as “red debt level” a debt ratio that exceeds 300%, are only allowed to issue new debt to roll over 85% of maturing bonds, according to Yang Xiaoyi, a researcher at BRI Data, an investment advisory firm to local governments.

The tighter rules come as China wants to boost infrastructure projects to stabilise economic growth, but also indirectly assure debt markets that even if not wholly transparent it has a plan to tackle potentially systemic debt risks in some regions as it pushes an ambitious domestic reform agenda, advisors told MNI.

FLASHING RED

China’s Ministry of Finance earlier this year divided local governments and their financing vehicles into four colours that signify debt ratio urgency - red, orange, yellow and green. But it keeps the list a secret. Still, this allows the market to make educated guesses on colour tags for new bond issues based on whether they are accepted or rejected by stock exchanges, Yang noted.

In theory, the limits can force heavily indebted LGFVs, mainly located in the mid-west of the country, into a liquidity crunch with the purpose to get them to trim principal and reel in off-balance-sheet debt, effectively government-backed bonds that are not tied to municipal finances, said a research source who asked not to be named.

The push to get greater control over LGFVs is not new and follows other refinance and debt swap efforts.

Yang added that some popular LGFVs in Hunan, Shandong and Jiangsu provinces that previously overstretched borrowing may also feel the pain.

But advisors stressed LGFV bond defaults in the open market are unlikely. Instead, it will pressure LGFVs to accelerate asset disposals to optimise debt structures.

"China has strong risk management capabilities and LGFV bonds are still back by government credit," said Zhang Yiqun, director of a fiscal studies institute affiliated with Jilin province's finance department.

Yang agreed that defaults are not expected for these quasi-municipal bonds, but LGFVs will feel the pain of less liquidity and higher financing costs. She added that market sentiment based on the renewed tightening of financing channels could further pressure some poorly operated financing platforms.

RESOLVING IMPLICIT DEBTS

Limiting some new LGFV bonds has made room for more approved bond refinance that can replace local implicit debts early next year, said Yang.

By November, it is reported that there were over CNY600 billion out of about CNY2.9 trillion of refinancing bonds were issued for "repaying outstanding debts". The figure stoked speculation that some implicit debts are being refinanced in this way. Normally, a bond prospectus will give finer details, making the description for this CNY600 billion stand out.

More special refinancing bonds are given to developed regions to help accelerate their progress on resolving implicit debts, so to help release their investment potential, said Yang.

Zhang agreed and noted that Guangdong province and Shanghai city are undergoing a pilot program of "no implicit debt".

Over a longer horizon, developed areas would be led to form more high-quality assets, and drive investment growth, said Zhang. That would be bolstered by a higher quota of local government special bonds tilting to these regions.

Though LGFVs used to be important fundraisers in every province for urban infrastructure projects, they are now facing pressure from Beijing to operate more independently as corporates, focusing on developed areas and self-sustained, profitable projects.