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Local government bonds to instill 'debt discipline' – Moody's
By Lydia Chen |
September 19, 2011, Monday
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Online Edition
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CHINA'S pilot program to allow local government to issue bonds will help local administrations to be disciplined in dealing with their debts while providing them with an alternative amid alleviating liquidity pressure, Moody's said today.
The start of these pilot programs in the country's advanced coastal provinces of Shanghai, Zhejiang, Guangdong and Shandong, are credit positive, as they will enhance local governments' discipline and transparency in managing their debts, the ratings agency said in a report.
More importantly, these programs would expand their sources of funding, which to date have relied heavily on bank loans to the so-called "local government financing vehicles," analysts Kai Hu and Jiming Zou said in the report.
Local governments in China have accumulated 10.7 trillion yuan (US$1.7 trillion) in debt, equaling 27 percent of the country's 2010 GDP, according to China's National Audit Office.
Because Chinese law had previously prohibited local governments from incurring debt, various levels of local administrations had created thousands of LGFVs with which to borrow from Chinese banks.
The US-based ratings giant expected China's local government debt to be 3.5 trillion yuan more than the auditors had estimated, potentially putting banks on the hook for deeper losses that could threaten their credit ratings, according to a previous report by Moody's in July.
China's mountain of local government debt has long been seen as a major risk by investors. The worry is that slower growth in the world's second-biggest economy could set off a wave of loan defaults and hobble its banking system.
Moody's said a jump in local government loan defaults could push the non-performing loan ratio for Chinese banks as high as 12 percent, well above its base-case scenario that envisions losses in the range of 5 percent to 8 percent.
Government figures show the average NPL was 1.1 percent at the end of March.
Earlier this year, news of a few potential LGFV defaults raised concern about these vehicles' lack of transparent information disclosure, poor financial discipline, inadequate cash flows, and weak or nonexistent collateral.
These concerns, along with China's tightened environment of bank credit, have challenged local governments' finances and LGFVs have encountered difficulties in securing new loans. Many local governments lack sufficient funds to refinance heavy debt loads that mature over the next three years and were incurred on unfinished infrastructure and subsidized housing projects mandated by the central government.
Such funding shortfalls have prompted some companies, including large state-owned enterprises engaged in infrastructure and construction, to lend to local governments via build and transfer and build, operate, and transfer projects as a way of securing new business.
Local governments represent an important client segment, but in some cases lack cash to make final payments for projects and instead pay companies by awarding land-use rights and utility concessions. Such unconventional forms of payment have increased contractors' need for working capital and put pressure on their balance-sheet liquidity.
The pilot program is a positive step toward alleviating liquidity pressure among local governments by providing them with alternative sources of funding, Moody's said in today's report. Issuance of this form of public debt will require more transparent disclosure of information and stronger fiscal management.
Nevertheless, rolling out a few pilot projects into a nationwide program faces legislative and political barriers that mean the full benefit to these companies will materialize only in the next two to three years, it added.
The start of these pilot programs in the country's advanced coastal provinces of Shanghai, Zhejiang, Guangdong and Shandong, are credit positive, as they will enhance local governments' discipline and transparency in managing their debts, the ratings agency said in a report.
More importantly, these programs would expand their sources of funding, which to date have relied heavily on bank loans to the so-called "local government financing vehicles," analysts Kai Hu and Jiming Zou said in the report.
Local governments in China have accumulated 10.7 trillion yuan (US$1.7 trillion) in debt, equaling 27 percent of the country's 2010 GDP, according to China's National Audit Office.
Because Chinese law had previously prohibited local governments from incurring debt, various levels of local administrations had created thousands of LGFVs with which to borrow from Chinese banks.
The US-based ratings giant expected China's local government debt to be 3.5 trillion yuan more than the auditors had estimated, potentially putting banks on the hook for deeper losses that could threaten their credit ratings, according to a previous report by Moody's in July.
China's mountain of local government debt has long been seen as a major risk by investors. The worry is that slower growth in the world's second-biggest economy could set off a wave of loan defaults and hobble its banking system.
Moody's said a jump in local government loan defaults could push the non-performing loan ratio for Chinese banks as high as 12 percent, well above its base-case scenario that envisions losses in the range of 5 percent to 8 percent.
Government figures show the average NPL was 1.1 percent at the end of March.
Earlier this year, news of a few potential LGFV defaults raised concern about these vehicles' lack of transparent information disclosure, poor financial discipline, inadequate cash flows, and weak or nonexistent collateral.
These concerns, along with China's tightened environment of bank credit, have challenged local governments' finances and LGFVs have encountered difficulties in securing new loans. Many local governments lack sufficient funds to refinance heavy debt loads that mature over the next three years and were incurred on unfinished infrastructure and subsidized housing projects mandated by the central government.
Such funding shortfalls have prompted some companies, including large state-owned enterprises engaged in infrastructure and construction, to lend to local governments via build and transfer and build, operate, and transfer projects as a way of securing new business.
Local governments represent an important client segment, but in some cases lack cash to make final payments for projects and instead pay companies by awarding land-use rights and utility concessions. Such unconventional forms of payment have increased contractors' need for working capital and put pressure on their balance-sheet liquidity.
The pilot program is a positive step toward alleviating liquidity pressure among local governments by providing them with alternative sources of funding, Moody's said in today's report. Issuance of this form of public debt will require more transparent disclosure of information and stronger fiscal management.
Nevertheless, rolling out a few pilot projects into a nationwide program faces legislative and political barriers that mean the full benefit to these companies will materialize only in the next two to three years, it added.
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