Chinese Investors Flock to Local Government Bonds Amid Beijing’s Efforts to Tackle Debt
Chinese Investors Find Safety in Local Government Bonds
Chinese investors are eagerly purchasing bonds issued by local government financing vehicles (LGFVs), even those with higher risk profiles. This surge in demand comes as Beijing takes new measures to address local debt risks, enticing investors with the prospect of an implicit government guarantee.
The Appeal of LGFVs in a Volatile Chinese Economy
In the midst of a turbulent Chinese economy, where stocks and property bonds have taken a hit and the yuan continues to weaken, LGFVs have emerged as one of the few popular investment options. These vehicles have become increasingly attractive due to their potential for higher yields.
Refinancing Bonds: A Solution to Debt Risks
Several local governments, including heavily indebted ones like Yunnan and Guizhou, have initiated the sale of refinancing bonds as part of a special program to replace other forms of borrowing. This bond issuance, projected to reach 1 trillion yuan ($136.79 billion) by year-end, is seen as a strategy by Beijing to mitigate debt risks associated with LGFVs.
Boosting Confidence in LGFVs
As local governments raise fresh capital through refinancing bonds, investors expect LGFVs, which have been hindered by a struggling property sector and a weak economy, to remain well-funded. The market is responding positively to this new opportunity, leading to a substantial influx of funds into LGFV bonds and a significant compression of credit spreads.
Lower Yields Benefit LGFVs
The decrease in bond yields, coupled with the inverse relationship between yields and prices, is advantageous for LGFVs as it allows them to borrow at more affordable rates. Data from ChinaBond indicates that the credit spread of 1-year LGFV bonds rated ‘AA-‘ has reached its lowest level this year, shrinking by 61 basis points since August.
LGFVs Regain Popularity Amid Debt Concerns
Although LGFV bonds, estimated to be around 13.5 trillion yuan, faced challenges earlier this year due to fiscal strain, they have experienced a resurgence in popularity since July. The commitment by China’s Politburo to address local debt problems, coupled with the issuance of refinancing bonds by local governments, has further bolstered confidence in these investment instruments.
Government Intervention and Investor Confidence
Sources have revealed that the People’s Bank of China has instructed major state lenders to extend loan tenors and reduce interest rates on existing LGFV loans. This move is expected to provide additional support to LGFVs, reassuring investors of the government’s commitment to prevent defaults.
The Growing LGFV Debt Challenge
LGFVs were established by local governments to circumvent Beijing’s fiscal budget and borrowing limits. However, due to the perceived government guarantee, LGFV debt, including loans, bonds, and shadow bank borrowing, has surged to approximately 60 trillion yuan, posing a threat to China’s financial stability.
Easing Debt Burden through Refinancing Bonds
The proceeds from refinancing bonds, which carry coupons of around 3%, are expected to replace high-interest LGFV debts that reach up to 10% in some cases. This strategy will buy time for highly indebted regions such as Guangxi and Shandong, allowing them to address their most pressing debt concerns.
Confidence in LGFV Bonds
Unlike private property developers, LGFVs are state-owned, leading investors to believe that the central government will prevent bond defaults. The focus is on government policies rather than the financial standing of LGFVs, with many considering LGFV bonds to be a safe investment option.
Controversy and Skepticism
While some credit research firms, such as YY Rating, share the optimistic view regarding the safety of LGFV bonds, others like Rhodium Group express skepticism. Rhodium Group argues that LGFV bond investors are taking significant risks, cautioning that if an LGFV bond defaults and undergoes restructuring, creditors will bear the majority of the cost.
