China banks balk at local debt-swap plan

Several Chinese provincial governments have been forced to postpone bond auctions as banks balk at the low yields on offer, state media reported on Friday, highlighting the challenges of carrying out a Rmb1tn ($161bn) plan to lower financing costs for cash-strapped localities.

China's local debt has surged since the 2008 financial crisis as regional governments borrowed to finance infrastructure projects in an effort to stimulate the economy. Economists have warned that the debt poses a risk to the banking system.

China's finance ministry last month revealed a plan for provincial governments to refinance Rmb1tn in debt due to mature this year. The goal is to lower debt-servicing costs and extend maturities by converting short-term, high-interest bank loans to low-interest, long-term municipal bonds.

Much local borrowing has been channelled through arms-length financing vehicles (LGFVs) that local governments established to circumvent a legal ban on direct borrowing. China's legislature formally rescinded that ban last year, in a bid to "open the front door and close the back door" to local borrowing.

In addition to lowering financing costs, the finance ministry's debt swap plan aims to inject transparency into local finances by converting debt accumulated through opaque LGFVs into direct obligations of local governments.

Local governments are not legally responsible for repaying LGFV debt, but investors largely viewed such debt as carrying an implicit government guarantee - an ambiguity that elevated yields. Converting the implicit guarantee into an explicit one is intended to lower yields.

But Economic Information Daily, an affiliate of the official Xinhua news agency, reported on Friday that east coast Jiangsu province and central Anhui province will both postpone bond auctions after underwriters failed to drum up enough demand for the paper at yields the provincial governments were prepared to offer.

Demand from commercial banks is crucial to local governments' ability to sell debt, since banks own 63 per cent of all bonds traded in China's interbank market, according to data from China's two main bond clearing houses.

"Banks aren't very enthusiastic about this plan," said Sun Binbin, bond analyst at China Merchants Securities in Shanghai.

"Maybe the bank president has a positive attitude because he wants to establish good relations with the local government and open up other business opportunities in the region. But for the treasury department, they're under pressure. Other business lines aren't part of their KPI [key performance indicator]. They'll take losses on these bonds - rates are low, and liquidity is poor."

Rating agency Standard & Poor's late last year estimated that half of all Chinese provinces would merit junk ratings, though it did not issue ratings for specific provinces.

Yet local government bonds sold under a pilot project for municipal bonds, which was restricted to wealthier provinces, have been sold at relatively low rates.

Jiangsu bonds maturing in about five years yielded 3.55 per cent on Thursday, above the 3.29 per cent yield on Chinese government bonds but below five-year bonds from China Development Bank, the state-backed non-commercial "policy bank."

Chinese localities had accumulated Rmb17.9tn in debt by mid-2013, according to the latest official tally. Jiangsu, a wealthy but deeply indebted province, had announced plans to sell Rmb65bn in bonds in the first auction, while the relatively poor province of Anhui planned to sell Rmb26bn.

Additional reporting by Ma Nan in Shanghai

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