SHANGHAI, Sept 28: While investors scrutinize China’s monthly bank lending data for signs of economic stimulus, bonds are quietly replacing bank loans as the key source of funding for stimulus-style investment projects, especially for local governments.
Bonds exceeded loans in terms of new medium- and long-term (MLT) corporate credit creation in August, an enormous shift for a financial system traditionally dominated by bank lending.
Firms issued 158 billion yuan ($25.07 billion) in net new MLT bonds in August, compared with only 120 billion yuan in MLT corporate loans, data from the central bank and China’s two main bond clearing houses shows.
MLT bonds have exceeded MLT loans three times over the last ten months, a pattern that had never occurred prior to November last year.
Much of the recent bond funding has flowed to local governments, which analysts say are much more eager than the central government to implement a fresh round of stimulus similar to the 4 trillion yuan campaign launched in 2008.
New bond issues by local governments totaled 96 billion yuan in the four months from June to September, up sharply from only 30 billion in the first five months of 2012, according to Thomson Reuters’ bond databases. That puts new local government bond issuance on pace to grow 33 percent year-on-year in 2012.
The bonds are being used to finance projects such as affordable housing, water conservation, and highways. But they are still included in the long-term corporate bond totals because China’s budget law forbids local governments from taking out loans or issuing bonds directly. Instead, they issue debt mainly via arms-length platform companies known as local government financing vehicles (LGFV).
BANKS RETREAT
The shift from loans to bonds comes as banks face increasing pressure from both regulators and shareholders to reduce exposure to debt-laden local governments.
Banks were burnt in 2008/09 when they lent heavily to local governments to build roads and railways, only to find many loans could not be repaid on time and had to be restructured.
The shift is a victory for central bank governor Zhou Xiaochuan, who for years has worked to develop China’s domestic bond market, partly as a means to diversify risk away from the banking system.
But further accumulation of debt by local governments raises longer-term risks for the economy, as many localities carry massive debt loads racked up during China’s vast 2008/09 stimulus.
In a speech delivered in April but published last week, Zhou said that local governments should issue bonds mainly to local citizens who are able to impose spending discipline and restraint against excessive debt.
‘If the issuing bodies are provincial or city governments, but the market is a national market, problems of unrestrained borrowing, moral hazard, and failure of the pricing mechanism will appear,’ he said.
IMPLICIT GUARANTEE
Chinese asset managers are eagerly lapping up the latest wave of local government debt, drawn by generous yields, but the love affair could end in tears because those local governments may be taking on more debt than they can sustain.
Chinese officials began sounding the alarm about local government debt in 2010, and as recently as March were still issuing rules aimed at restraining new debt. But priorities shifted as the severity of China’s economic slowdown became apparent.
Estimates of China’s total local government debt vary widely, even among different agencies within the central government. Based on an analysis of the competing government estimates, GaveKal-Dragonomics, a Beijing-based consultancy, estimates that local debt totaled 14.7 trillion yuan, or 37 percent of China’s GDP, by the end of 2010.
The new wave of local debt has been unleashed by the National Development and Reform Commission (NDRC), the powerful economic planning agency that wields approval authority over both the ‘enterprise bond’ market and the investment projects largely financed by such bonds.
‘The NDRC’s blessing provides an implicit government guarantee, so bond defaults are highly unlikely. As a result, fund managers and banks are rushing to buy these low-rated, high-yield bonds,’ Zhang Zhiming, head of Chinese research for HSBC, wrote recently.
The enterprise bond portion of total bond holdings by fund companies hit an all time high of 22 percent in August, up from 17 percent a year earlier. Most enterprise bonds issued over the last year have been from LGFVs.
Another big source of demand for local government debt is coming from so-called ‘wealth management products’ (WMP) issued by commercial banks.
Issuance of these short-term products has soared over the last two years, as investors search out higher returns than those available from traditional bank deposits.
Zhang says that the bailout of Shandong Helon earlier this year reinforced the belief that the government would not allow a LGFV to default.
Helon was a partially state-owned textile company that came close to becoming modern China’s first-ever domestic bond default earlier this year before the local government stepped in with a last-minute rescue. ($1 = 6.3025 Chinese yuan)
(agencies)
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