China bonds

China's bond reform falls short

China’s first local government bonds without central government backing still do not show market forces at work.
Ningxia, one of China's most indebted provinces, has a triple-A rating from Dagong
Ningxia, one of China's most indebted provinces, has a triple-A rating from Dagong

The first local government bonds without central government backing are a positive step but still do not allow enough room for market forces.  

Until now four provinces have issued government bonds in their own name but credit analysts have noticed that the central government hasn’t stepped away from the pricing process.

In May, China’s Ministry of Finance for the first time allowed 10 local governments to tap the bond market under their own steam for around Rmb120 billion ($19.7 billion). The 10 are Shanghai, Zhejiang, Guangdong, Shenzhen, Jiangsu, Shandong, Beijing, Jiangxi, Ningxia and Qingdao.

Previous issuance from the local governments - in the name of the MoF - came with an implicit guarantee from central government.

So the changes mean the local governments can now assume default risk themselves, while backing their debt with their own revenue, making their bonds financial products with prices determined by market forces.

However, the yields of the provincial bonds are even lower than those of bonds issued by the MoF. For example, the three tranches of the Shandong bond issued on July 11 were priced 20 basis points lower than those of central government bonds with the same tenor.

This is strange because investors would be expected to ask for higher returns from possibly riskier issuers given their credit reliability and bond liquidity are lower than the central government.

“The first local bond transactions were still not led by market principles as the central government said they would expect,” Chen Long, head of financial market department with Bank of Dongguan, told FinanceAsia“This means that the prices [of the bonds] were not really determined by investor demands.”

He mentioned several reasons for the unusual price performance, including that local investors might have been asked by the local governments to participate, or they might have been promised compensation in other ways for subscribing.

Also, the ratings and underwriting processes need to introduce more market forces, analysts said.

The western province Ningxia, which is looking to issue Rmb5.5 billion three-tranche bonds in its name on August 11, was rated AAA by domestic agency Dagong Glocal Credit Rating, the same rating as bonds of Guangdong, known as China’s wealthiest province.

Standard & Poor’s, which has spent the past few years assessing the creditworthiness of several local governments in China, found wide variation among regions.

Coastal provinces Shandong and Guangdong have the lowest debt-to-revenue ratios among the areas S&P covered, at slightly more than 100%, while the figures of inland provinces such as Jiangxi climb to more than 300%, S&P said in a report.

Ningxia’s debts grew 20.8% year-to-year to Rmb87.4 billion as of end-2013 and its debt ratio listed 29 among China’s 34 provincial-level administrative regions.

“If the governments are all rated at the same level, there is no risk difference among them. Then how will investors do valuation-finding?” asked a Shanghai-based credit analyst.

None of the ratings reports about the three local government bonds issued directly point out risk factors, which should be a main concern for bond investors in a normal market.

The seven local governments that have unveiled bond offering proposals said they would hire investment banks mainly based on their hard-underwriting promises — promises of how many bonds and at which yield level they can sell to investors before any market roadshows is done.

Among the factors the local governments listed to grade banks, the hard-underwriting capacity accounts for the largest portion. This is compared to other factors such as the banks’ historical underwriting record and their strength in balance sheet.


Analysts admitted there are some measures that have flagged positive changes in local government debt market.

For example, Beijing hired a third party — China Capital Tendering — to mandate underwriters, the first time this has happened in local government bond issuance.

The participation of independent parties will help reduce opacity and inefficiency, according to analysts.

"Rating agencies will help to improve information disclosure of local governments’ financials and debts," Huo Zhihui, chief analyst of public institutions with Beijing-based China Credit Rating, told FinanceAsia. In Huo's rating report on the Jiangsu bond, the local government has for the first time publicised some of its financial revenues and expenditures.

“We are building up experience through this issuance. We hope more local government information disclosure and will improve our rating system,” said Huo.

Some analysts hold a positive view towards the market, which they said would become mature as time goes by. “Local government bonds are now more policy-driven not market-driven. But the market is nascent. We need to have more patience,” said Li Ning, a Shanghai-based credit analyst with Haitong Securities. 

“A comprehensive legal system, more supplies and liquidity, as well as retreat of central government with implicit guarantee, will all help in building up a mature and healthier market,” said Li.

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