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--Poorer Local Governments to Bear Brunt of Higher Borrowing Costs
BEIJING (MNI) - The ongoing divergence between the lower yields of bonds
issued by well-heeled Chinese local governments -- particularly the nation's
biggest provinces and cities -- and much higher yields demanded for issues by
poorer rural governments, will exacerbate the fiscal problems that many local
governments face next year.
Tightening liquidity conditions and stricter regulation of financial
institutions is prompting investors to be more selective in their local
government bond (LGB) investments. Local governments with weak fiscal conditions
are being forced to pay more to borrow, which will weigh on local budgets even
as demand to finance infrastructure spending remains high.
Given expectations that the government's financial deleveraging campaign
will continue unabated, the divergence in LGB yields could widen further,
increasing pressure on local governments' financing.
As of Monday, yields on 10-year, five-year and one-year local government
bonds had all registered double-digit percentage gains since the beginning of
According to Wind Information, the yield of 10-year LGB on average has
increased by 29.59%, or 98.87 basis points, to 4.3302% from 3.3415% on December
31 last year. The five-year LGB yield rose 32.10%, or 102.21bp, to 4.2061%,
while the one-year LGB average yield climbed 35.72%, or 105.02bp, to 3.9905%.
The pickup in LGB yields has been driven by increasing yields of benchmark
Chinese government bonds (CGB), changes in which affect all categories of bonds
amid tight liquidity, according to analysts interviewed by MNI.
The central government's policies to rein in local government debt risks
and promote more market-oriented financing of local governments result in
greater differentiation of local government bond risks, Ivan Chung, head of
Moody's Greater China Credit Research and Analysis, told MNI.
Under current tight liquidity conditions, the perceived riskiness of local
government borrowers has a big influence on credit differentiation, resulting in
a widening of spreads between relatively lower-rated LGBs and CGBs. The changing
landscape will make investors increasingly selective in choosing what LGB to
buy, Chung said.
"Increasing yields will push up the issuance cost of local government
bonds," Pei Yonggang, chief ratings director of Beijing-based Golden Credit
Rating said in an interview with MNI. "It will add to the fiscal burdens of
provinces that have relatively weak economic and fiscal ability."
Data from Golden Credit Rating show the yield that local governments must
pay on their bond issues is directly related to the sizes of their fiscal
revenue and outstanding debt. Coupon rates for bonds issued by Guangdong,
Shanghai and Beijing in the first three quarters this year were close to those
of CGBs of the same maturity, because of their fiscal revenues ranked,
respectively, first, third and sixth among the nation's 34 provincial level
provinces and cities. However, Liaoning, Gansu, Inner Mongolia, and Ningxia
provinces, whose fiscal revenues are relatively low and debt ratios relatively
high, had to pay coupon rates generally 60 basis points higher than CGBs of the
same maturity, according to the rating agency.
The increase in LGB yields will slow the issuance of LGBs by some
provinces, Pei and Chung predicted.
"Unless there's a big funding need, local governments will reduce the size
of their issuance," Chung told MNI, though some of this reduction is due to
smaller debt swap demand. In the past two years, some 80% of LGB issuance was
used in debt-for-equity swaps for old debt issued by local government financing
vehicles or direct other legacy debt obligations. "The amount of debt that needs
to be swapped is smaller this year and it will also result in the smaller
The financing costs for local government financing vehicles (LGFVs) will
also increase as local governments are still the main source of revenues for
repaying the bonds and so the market still prices LGFV bonds based on the credit
risks of corresponding local government, several analysts said.
Analysts are divided on their outlook for local government bond yields,
though they agreed that changes in CGB yields would remain the most important
factor in the yields of LGBs. Both liquidity conditions and government policies
will continue have a major influence on LGB issuance volume and yields.
Terry Gao, senior director of Fitch Ratings, predicted that LGB yields
would remain stable next year.
Moody's Chung said that LGB yields would at least maintain at this year's
levels and could very well increase in 2018. He noted that the People's Bank of
China is expected to maintain tight liquidity conditions next year as the
central government continues its deleveraging campaign.
"The government will not inject lots of liquidity [into the market] to
lower [bond] yields, because that would slow down the deleveraging in the
market," Chung told MNI.
Golden Credit Rating's Pei said yields on medium- to long-term LGBs could
continue to tick up because of relatively tight liquidity conditions and
stricter financial regulations. The higher yields will lead to lower issuance by
some local governments for the full course of 2018.
Despite higher yields, LGB issuance will rise significantly in the first
half of next year as part of the Chinese government's three-year debt swap
program started in 2015, Pei said. That program aims to swap high-interest-rate
debt issued by local governments and their LGFVs for bonds with much lower
interest rates, with CNY3.6 trillion in LGB/LGFV bonds left to be swapped next
year to fulfill the program quota, Pei said.
Provinces that have already issued large amounts of bonds this year -- such
as Jiangsu, Hubei, and Hunan -- are expected to slow their issuance next year,
while provinces that issued less debt this year -- such as Beijing, Guangdong,
Liaoning, Shandong and Zhejiang -- are likely to speed up their issuance, Pei
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