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February 2, 2015

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Home » Business » Finance Special

Islamic bonds a first for regional government

By Feng Jianmin | February 2, 2015, Monday | Print Edition

Ningxia, a Muslim minority autonomous region in northwestern China, announced plans in December to sell up to US$1.5 billion in bonds overseas. If approved, it will mark the first time local government bonds in China will be sold offshore.

The bonds will be a combination of dollar-denominated debt and sukuk, the Islamic equivalent of bonds, with terms of five years or less.

By tapping the sukuk market and its dominant Middle East investors, Ningxia is hoping to use religious ties to tap a new source of capital.

Islamic law forbids Muslims from investing in interest-bearing assets. A sukuk bond skirts that ban by giving the investor part of the ownership of the underlying property rather than cash interest payments.

Ningxia, where about a third of the population is Hui, a Muslim minority, was one of 10 regional or local governments allowed last May to issue and repay their own municipal bonds.

The move is part of a trial to clean up the Chinese local government debt market and relieve the central government of liability for local government debt.

Previously, regional local governments in China had to depend on the central government to issue bonds on their behalf or on companies known as local government financing vehicles to issue bonds.

The lack of transparency in these financing vehicles sparkled widespread worries about the real size of China’s local government debt.

Shanghai Daily invited Debra Roane, vice president and senior credit officer in the global sub-sovereign group at Moody’s Investors Service, to share her views on the impact of this project.

Q: What’s the significance of this government bond issuance?

A: The tighter discipline of offshore markets should enhance the transparency and accountability of participating Chinese regional local governments and encourage responsible fiscal behavior.

Offshore issuers will be able to attract a more diversified investor pool, adding to liquidity and potentially lowering funding costs, although they will also need to manage additional risks such as foreign currency exposure.

Ningxia’s plan would make it the first Chinese regional local government to issue bonds offshore, a logical next step in the evolution of the country’s regional local government bond market.

Nevertheless, the market’s development is proceeding faster than most international investors had expected and details are still lacking on how offshore bond issuance will fit within the central government’s plan for debt reform.

Q: How active is the market for sukuk bond in general?

A: Volumes of sovereign sukuk have increased significantly over the last three years as governments in Asia, the Gulf, Europe and now Africa seek to tap increased demand for Shariah-compliant financial assets.

In addition, 2014 has become a landmark year for the sector.

The United Kingdom issued its inaugural sukuk, and Hong Kong and South Africa concluded sales in September 2014. All three are major non-Islamic regions and indicate a significant change in the potential size, depth and liquidity of this market.

We estimate that total sovereign outstanding accounts for around 36 percent of the US$296 billion of outstanding sukuk as of July 2014.

 Q: Do you expect more Chinese local governments to issue bonds offshore? How will these bonds be rated?

A: At this point, the extent to which local governments decide to access offshore markets is not clear. 

Up until now, the development of a debt market for Chinese regional local governments has proceeded in a step-by-step fashion, with authorities recognizing the need for a more direct borrowing model. Clearly, this is the direction they would like to see local governments take, given the revision in the budget law, which will allow local governments to issue bonds directly, and the State Council’s directive that further outlines the parameters for local government borrowing.  

The timing of the development of a full functioning debt market, however, remains unclear as the government is in the process of putting in place the various regulatory framework, budgetary and accounting systems that will be needed to support a successful local government bond market. 

 

Q: Will Moody’s evaluate risks of Chinese local government debt and nation’s sovereign debt differently if Chinese local governments continue to issue bonds offshore?

A: The impact of foreign currency debt on local governments would have to be analyzed on a case-by-case basis and include an understanding of how they would manage additional risks, such as foreign currency exposure.

The vast majority of local governments globally issue debt in domestic currencies, but there are some larger and more sophisticated local governments all over the world that have successfully used foreign currency markets to diversify their investor base and achieved favorable terms. 

Finance Special


 

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