China's infrastructure stimulus

China uses special bonds to lure foreign investors

As the Sino-US trade war slows down GDP growth, Beijing is reforming its state infrastructure bonds to stimulate both international demand and infrastructure investment.
China will issue more special bonds to finance infrastructure projects.
China will issue more special bonds to finance infrastructure projects.

A large uptick in the issuance of so-called special bonds in China is likely to occur following a government notice that could make special bonds more market-driven and could attract more international investment.

Special bonds are Chinese local government bonds which raise funds for specific infrastructure projects like railways and power stations.

“As the next step, the relevant state departments will direct local governments to accelerate the pace of bond issuance to expand investment,” said a statement posted on the Chinese government website on Tuesday.

Rmb859.8 billion ($124.3 billion) of special bonds were issued in China in the first five months this year, it said.

“The new regulation is a step forward to stimulate domestic demand and infrastructure investment,” Gary Ng, Asia economist at Natixis, told FinanceAsia.

Many analysts believe that as the Sino-US trade war slows down GDP growth, the Chinese government will stimulate the nation’s economy,   

A notice on improving local government special bond issuance, published on the Chinese government website on Monday, encourages local governments and financial institutions to use special bonds to finance mega-projects like the Belt and Road Initiative, China’s plan to connect with other countries through infrastructure projects.

To underscore its importance, six government departments published the notice: the Ministry of Finance, the National Development and Reform Commission (NDRC), the People’s Bank of China (PBOC), the National Audit Office, the China Banking and Insurance Regulatory Commission (CBIRC) and the China Securities Regulatory Commission (CSRC).

The special bonds hope to attract more international investors through various channels including Bond Connect, which allows foreign investors to trade Chinese onshore bonds via Hong Kong.

In the first five months this year, international investors traded Rmb617.3 billion of Chinese bonds via Bond Connect (in May it introduced the first batch of investors from New Zealand, which expands its coverage to 28 jurisdictions) and for the first time, the US overtook Hong Kong. It had the highest market share for accounts opened, at 28% of Bond Connect’s investor base. Policy financial bonds and Chinese government bonds accounted for 47.7% and 16.6% of Bond Connect’s trading in May respectively.

From an international investor perspective, any measure to strengthen the quality of issuance is welcome, said Vincent Au, head of investment at Hong Kong wealth advisory firm ALPS Advisory. “If a bond is tied to a specific infrastructure project, it helps, as the cashflows will then be defined and something that you can calculate with. But ultimately, government implicit guarantee is still the most important factor.”


The notice holds provincial governments fully responsible for repayment of the special bonds. On the other hand, the local governments’ role in special bonds will be reduced. They are forbidden from influencing the pricing of the special bonds or pressurising underwriters to price the bonds according to conditions of their localities and projects.

As another market-oriented measure, companies that manage infrastructure projects will be allowed to issue corporate bonds to supplement the special bonds. The notice called for the development of a nationwide information platform on local government bonds, so that they can be independently rated.

Commercial banks should market special bonds to individuals as well as to small- and medium-sized institutions. It was only in March that retail investors were first able to buy local government bonds at banks in China. Insurers, funds and commercial banks will be encouraged to buy local government bonds too.

Banks currently hold most local government paper in China. The expansion of the investor base should support the development of the onshore bond market. The Chinese government may realise that an infrastructure push that relies solely on the public sector, may not be enough to buffer the country’s economic slowdown, reckons Ng. This is why different stakeholders need to share responsibility for stimulating the economy and for financial risks, he added.

The Chinese government now has to conduct a delicate balancing act between boosting the economy in this way and curbing excessive debt. Special bonds are not eligible to fund unprofitable projects. The notice allows local government financing vehicles (LGFVs) to partner financial institutions to fund infrastructure projects, provided that these projects are not unnecessarily expanded. Financial institutions can exercise discretion according to commercial principles in funding projects, so long as this does not give rise to hidden debt.

The statement admits that China’s local government debt includes illegal and disorderly elements, but said that these are starting to come under control. China’s local government debt reached Rmb18.4 trillion with a debt-to-fiscal strength ratio of 76.6% at the end of last year, according to official Chinese data.

Ever since Beijing started to crack down on shadow banking in 2017, the creditworthiness of Chinese LGFVs has become increasingly polarised. Stronger LGFVs can obtain better financing terms, but the opposite applies to LGFVs with lower policy relevance and a more commercial nature, widening the rating gap between the two groups, said ratings agency Fitch in a recent report.


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