S&P warns of inherent risks in local govt bonds

Half of China's local governments could warrant junk-level credit ratings, according to ratings agency Standard & Poor's Financial Services LLC, in stark contrast to the view of domestic ratings agencies.

While refusing to specify which provinces exactly might be considered as "junk", S&P said in a report that three provinces in Northeast China had what it called "speculative-grade credit features".

Wide differences exist between China's well-off eastern provinces and the less prosperous inland regions.

Eight out of the 10 provinces in eastern China were judged by S&P to have investment-grade features, while just two out of the six provinces in Central China, and five of the 12 in western China were given them.

S&P does not officially rate Chinese local governments and said its credit assessments were based on publicly available data and information, which is incomplete for some governments.

If additional information were to become available, it said its assessment of credit quality for some of these governments could differ.

Under S&P's normal criteria, issuers are given various ratings from the top AAA to D.

Even within "speculative-grade" ratings, there are various levels from BB, B, CCC to CC, each with different degrees of speculation.

S&P did not elaborate on the provinces with speculative features but emphasized that 15 other provincial governments had investment-grade credit profiles. These governments, eight in eastern China, "are likely to stay at this level for the next two years", it said, as they enjoy a higher level of wealth, greater physical and human capital, better governance and fiscal management.

Xie Yaxuan, head of macroeconomic research at China Merchants Securities Co Ltd, said "it is debatable whether foreign agencies' rating methodology can be accurately applied to China, and given the incomplete revenue and expenditure data on local governments, S&P's analysis should be viewed with caution."

S&P's analysis is in sharp contrast with the ratings given to the 10 provincial governments by domestic ratings agencies during May's municipal bond pilot program launched by the central government.

Despite the 10 involved varying in wealth - from rich municipalities such as Beijing and Shanghai to poor inland provinces and regions such as the Ningxia Hui autonomous region and Jiangxi province - the bonds issued by them unanimously received AAA ratings which entitled them to interest rates in line with central government bonds.

The three domestic agencies involved in the ratings declined to comment.

S&P's findings echoed those in an earlier National Audit Office survey, however, that showed vastly different debt to fiscal revenue ratios.

Beijing government's direct debt, for instance, is equivalent to about 100 percent of its fiscal revenue, the highest among provinces, followed by the municipality of Chongqing and Guizhou province, each with a more than 90 percent ratio.

Ivan Chung, senior vice-president at Moody's Investors Service Inc, said although financial profiles differ from region to region the gap in reality is narrowed by the central government's transfer payment system, and unlike the federal system, a region's repayment ability cannot be viewed individually.

Domestic agencies usually have less stringent rating standards than their international peers. Lenders widely view regional government bonds as carrying an implicit government guarantee, according to Chung, even though the central authorities have made it clear the 10 governments are expected to issue and repay the debt on their own.

"This is an extremely important trial bond program for the central government so investors believe Beijing is not going to let them fail. Moreover, the bond amounts issued through the program are very small while there are many bidders contributing to the low interest rate," Chung said.

As the program expands in geography and size, greater differences in pricing might occur, he said.

S&P also said in its report that several provinces have already seen low single-digit growth in general budget revenues, far below their 20 to 30 percent average yearly growth over 2010-12.