MNI EXCLUSIVE: Default Risk As China Urges Project Bond Sales

     BEIJING(MNI) - A surge in issuance of special-purpose bonds by Chinese

local governments as national authorities urge an increase in infrastructure

spending brings a growing risk of defaults due to a shortage of suitable

projects providing reliable revenue streams for the securities, policy advisors

told MNI.

     Special-purpose bond issuance could jump to CNY3.35 trillion in 2020,

equivalent to 3.2% of GDP, according to China International Capital Corporation

estimates. This compares to the national government's 2.8% deficit ceiling for

2019.

     While next year's official quota for the bonds will not be announced until

the National People's Congress next March, the Ministry of Finance said on

Wednesday that it had already pre-allocated CNY1 trillion, in order to

accelerate issuance and boost investment.

     The special-purpose bonds, largely paid back with returns from the projects

they are used to fund and not included in national government deficit

calculations, were introduced in 2015 to boost resources available to local

governments for investment. Issuance jumped to CNY2.15 trillion in 2019 from

CNY100 billion in their first year of existence, and has totalled CNY4.7

trillion so far, according to Ministry of Finance data.

     But there is already a shortage of projects which could generate sufficient

returns for the bonds, Wang Zecai, director of Government Performance Evaluation

Research Central at the Chinese Academy of Fiscal Sciences, run by the Ministry

of Finance, told MNI.

     "Some projects, particularly the quasi-public welfare ones, can barely pay

back their debt, so we need to monitor and evaluate the projects backed by these

bonds to avoid risks," Wang said, "According to the budget law, special-purpose

bonds should be repaid mainly using projects' returns. While some local

governments could tap revenue from government-managed funds to repay the debt,

that would not be sustainable."

     The government's move to pre-allocate a portion of next year's bond quota

has been seen as a move to boost fourth-quarter growth and support employment at

a time when the global economy is slowing, Wang said.

     "The newly-added special-purpose bond quota should play a positive role in

stabilising investment, reducing funding costs and easing the pressure of debt

repayments," he said.

     --SHORTAGE OF PROJECTS

     The interest rate on special-purpose bonds averaged 3.42% from January to

October, according to the Ministry of Finance. This compared with an average

3.53% for standard bonds issued by local governments.

     However, an advisor to local governments, who asked for anonymity, told MNI

that while moves to sell bonds could begin once quotas are assigned, issuance

would only succeed if the securities attract sufficient investor interest, and

if suitable projects can be found in time.

     Zhao Quanhou, director of the Financial Research Centre at the CAFS, said

finding projects was the biggest challenge for local governments looking to

issue the debt.

     "Local governments have been required to accelerate issuance despite the

shortage of projects, so we have to be on our guard in case they resort to

funding things which are second-rate," he said.

     Conditions for bond-funded projects have already been relaxed in response

to the shortage, the anonymous advisor said, saying: "The priority is to boost

infrastructure, so the policy should be flexible."

     Local governments need to be able to tap more sources to ensure that that

can meet payments on special bonds, advisors said.

     Wang suggested that local governments could take the special bonds directly

onto their balance sheets and be allowed to issue new debt to swap them out if

necessary. Local governments could also seek deals with private and overseas

investors to boost funding for some projects, Wang said.

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

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