MNI: China To Slow Local Government Offshore Financing Further

Local government financing vehicles will find issuing into the offshore bond market increasingly difficult as authorities aim to reduce their debt levels and the risk of asset mismatch between low return municipality projects and high offshore financing costs, a policy advisor and market insiders told MNI.

Strong demand in the LGFV sector drove the iBoxx USD Asia ex-Japan China LGFV High Yield index to return 1.3% over the month and 4.6% since late October, fuelled by investors’ renewed belief in Beijing’s implicit guarantee of debts raised by local governments’ investment entities to fund infrastructure projects. Bonds held within the index currently have an average yield of 9.21%.

Elle Hu, executive director of credit ratings at China Chengxin (Asia Pacific) Credit Ratings, told MNI regulators will increasingly reduce LGFVs’ ability to issue high-cost overseas debt to reduce financing costs of municipalities. The return of LGFV projects is generally low with long payback periods, making it hard to match against the high financing costs of the offshore bonds and raising the risk of asset-liability mismatch, Hu noted.

Investors remain enthusiastic for LGFV bonds and will support their short-term financing, Hu continued, noting some district- and county-level vehicles with weak credit have managed to execute short-term offshore bonds with relatively high financing costs. “They may face greater repayment risk and liquidity pressure as future debt rollover is highly uncertain amid tightening offshore issuance,” she added.

About USD26.8 billion LGFV offshore bonds will mature in 2024, followed by USD41.7 billion in 2025, Hu continued. While the overall credit risk remains low, any default will deteriorate the reputation of local governments, she noted.

The State Administration of Foreign Exchange ordered issuers in Shandong province at the start of the 2024 to suspend offshore issuance with maturities shorter than a year. Hu added SAFE’s move closed a regulatory loophole that allowed LGFVs that found domestic financing restrictive to fund themselves overseas and circumvent rules that required them to gain approval for borrowing outside China for maturities over one year.

In 2023, LGFVs issued 309 offshore bonds totalling about USD30 billion, a 28% drop from 2022 when issuance set a record high, she noted.

An official from a securities company in Hong Kong involved in underwriting the offshore bonds said the deals’ high yield went against regulators’ principles and was unsustainable. Onshore bond yields have already dropped rapidly amid Beijing’s initiative to resolve local debt risks, which included refinancing measures, the official noted. (See MNI: China To Launch Debt Swap To Address Implicit Liabilities)

An advisor close to the foreign debt regulatory department told MNI authorities aimed to control new borrowing while dissolving outstanding debts to reduce LGFV risks. (See MNI: PBOC Eyes CNY1 Tln Liquidity Tool For Local Gov't Debt)

WEAK CREDIT

The proportion of foreign debts borrowed by county-level LGFVs rose to a new high of 29% last year from 25% in 2022. Many of the deals were supported by standby letters of credit, effectively an underwriter’s pledge to repay if the issuer cannot, according to a report by Minsheng Securities, noting many will mature in 2025.

Hu said the supporting banks, mainly regional city commercial banks such as Bank of Shanghai and large state-owned institutions, will often reduce their risk by obtaining guarantees from other LGFVs in the same region.

Yang Xiaoyi, senior researcher at local government investment advisory BRI Data, expects tighter regulations on the qualification of offshore issuers in future to apply as far down as the county level.