Guangdong first to sell debt on own credit

Low-yield bonds snapped up in pilot program for local governments

Guangdong province, the first local government in China to directly issue bonds under a pilot program, sold 14.8 billion yuan ($2.38 billion) worth of debt at a low yield.

The province sold 5.92 billion yuan of five-year bonds at 3.84 percent, 4.44 billion yuan of seven-year bonds at 3.97 percent, and the same amount of 10-year bonds at 4.05 percent, according to a statement posted Wednesday on the China Central Depository & Clearing Co website.

Analysts voiced enthusiasm for the low-rate bonds, which are on par with those issued by the central government and much lower than the 7 percent rate for bonds previously issued by local governments' financing vehicles.

Most of the money raised will go to municipal construction, urban renovation and building of roads, the government statement said. According to another budget, 7 billion yuan will go for key intra-province infrastructure, while the rest will be used by counties in the province.

Guangdong is among the 10 provinces and cities across China that are allowed to issue bonds on their own credit and to assume responsibility for repayment of interest and principal. The pilot program has been hailed by credit rating agencies as an important step toward greater local accountability.

The cost of borrowing also is expected to be lowered. Shanghai Brilliance Credit Rating & Investors Service Co Ltd gave the Guangdong government bond an AAA rating, higher than the AA or AA+ usually accorded the so-called "chengtou notes" issued by local governments' financing vehicles.

Guangdong's total debt in mid-2013 was a whopping 1.02 trillion yuan, second only to Jiangsu province. But due to its economic strength, its debt-to-fiscal revenue ratio was just 59.41 percent, at the middle level among provinces.

Analysts said Guangdong's good financial position, along with the central government's extensive backing and the publicity it got as the first province to sell bonds, have contributed to the financing vehicle's popularity and low yield.

There are underlying worries about a possible inflated rating. Liu Shangxi, deputy director of the Research Institute for Fiscal Science at the Ministry of Finance, said that the conditions are not favorable for introducing credit rating for local governments.

He added that it's still unclear how to measure the asset values of local governments, and because there are no balance sheets available for them, there's no way to carry out accurate credit evaluations.

Ma Jun, chief economist at the central bank's research bureau, said stiffening local governments' "soft budget constraints" should be a precondition for allowing them to issue bonds. The "soft budget constraint" was considered to be behind the surge of local government debt to as high as 67 percent between 2010 and 2013.

Li Yan, an analyst with China Chengxin International Credit Rating, said it will take time for municipal bonds to replace the current chengtou notes and that in the short term, the yield of chengtou notes will not be dragged down by the local bonds.

Beijing firm sets the trend for overseas float

Beijing Infrastructure Investment Co's success in the overseas bond market might inspire more followers, analysts said.

BII is the urban rail transport arm of Beijing and is 100 percent owned by the municipality.

The company sold 1.2 billion yuan ($194.6 million) of three-year securities at 3.75 percent in Hong Kong last week, becoming the first Chinese subway company to tap the overseas bond market. The company issued $300 million of five-year dollar bonds at 3.625 percent in March.

"More local government financing vehicles are likely to follow suit for cheaper costs and flexibility," said Ivan Chung, senior vice-president of greater China credit research and analysis at Moody's Investors Services.

"There's a huge difference in onshore and offshore funding expenses. Also, the strong demand and limited supply of yuan products abroad is favorable."

Fiscal support from the Beijing government underpins Standard & Poor's Financial Services LLC's rating on BII (A+/Stable), the rating agency said. It said that the Beijing government funds the subway system's construction and cushions its operating losses through annual subsidies.

"We see an almost certain likelihood of extraordinary government support for BII because the company plays a critical role as the municipal government's sole company involved in rail transport investment and financing," the research note said.

Chung said not every local government financing vehicle meets the criteria to sell bonds overseas. BII features a sustainable financing structure, public-private partnership and, most important, the government's long-term funding commitment.