Chinese state investors sound alarm bells over cash crunch after defaults

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Chinese government entities tasked with funding hundreds of billions of dollars in infrastructure projects are struggling to raise liquidity after a series of state group defaults rocked the country’s credit markets.

Executives from several local government finance vehicles (LGFVs) told the Financial Times they abandoned bond sales or loan applications after state-owned companies went into debt, led by Yongcheng Coal & Electricity Holding Group, by default in November. Other LGFVs pay much higher interest rates to borrow.

The credit crunch facing LGFVs, which are responsible for channeling liquidity to Chinese local governments, has raised concerns that defaults by state-owned enterprises will spill over into other parts of an economy including the recovery of the coronavirus has been supported by infrastructure spending.

“LGFVs are one of the most important tools that Chinese local governments can use to achieve their political goals such as increasing investment and creating jobs,” said Dan Wang, chief economist at Hang Seng Bank China. “Many projects could be blocked if the LGFVs lose access to credit.”

While global capital inflows into the Chinese bond market have accelerated dramatically in recent years, most Western investors focus on bonds backed by the Chinese central government or political banks. The LGFV problem, one of the main components of China’s bond markets, will undermine Beijing’s efforts to attract foreign capital to its financial markets.

Many Chinese cities and provinces rely on LGFVs to raise capital on their behalf in order to bypass official restrictions on the use of leverage. According to Ms. Wang, they have been the main contributor to the rapid rise in China’s debt burden.

According to Institute of International Finance, China’s ratio of total debt – households, government, financial and non-financial enterprises – to GDP reached 335 percent in the second quarter of 2020, up from 318 percent in the first quarter of this year.

“We are the biggest creditor of local governments and the biggest debtor of the Chinese financial system,” said an executive of Hanjiang Urban Construction Development Co, an LGFV based in eastern Jiangsu province, who was not authorized to speak. to the media.

State-owned enterprise failures have also shattered investors’ long-held perception that Chinese authorities will always intervene to rescue financially jeopardized state groups.

“We will have problems when the authorities are too called upon to bail us out,” added the executive.

In 2019, LGFV loans accounted for nearly half of new loans to Chinese companies and a third of corporate bond issues, according to official data.

The figures also show that LGFVs, which collectively are China’s biggest spenders on construction projects, sold a record Rmb 3.4 billion in bonds in the first three quarters of this year, a jump of 31% compared to the previous year.

These bonds have historically benefited from strong investor demand due to their high credit ratings, although projects such as roads and bridges have suffered from rock-bottom profitability and a lack of cash flow.

However, total LGFV bond issuance has fallen 14% year-on-year since Yongcheng reneged on debt repayment nearly a month ago, according to news provider Wind.

“Investors don’t see us as a viable business when government support is gone,” said an executive from Chengfa Investment Group, an LGFV based in east China’s Shandong Province. The company last week abandoned its plan to issue an 820 million Rmb bond due to the “market crisis”.

Bank loans have also dried up for many troubled LGFVs. An executive at Zhongyuan Bank, a creditor of several government-controlled investment platforms, said the lender had “significantly” tightened standards for LGFV borrowers to control its risk.

“Before, we worked with all state-backed platforms, regardless of their fundamentals,” the executive said. “Now we pay close attention to their debt ratio and sources of debt repayment before approving or denying their loan applications.”

LGFVs that can still borrow have to pay more for this privilege, which in itself could add to the financial stress.

Public records show that, on average, yields on new bonds issued by LGFVs have jumped 4.8% since Yongcheng defaulted. This compares to less than 4% in the first nine months of the year.

This has made it much more difficult and costly for LGFVs, many of which are heavily in debt, to roll over their existing debts.

“If we don’t borrow now, we’ll have a hard time servicing the debt due next month,” said an executive from the Yan’an Urban Construction Group.

The LGFV has had to accumulate an additional 180 basis points on average to borrow on the bond markets over the past nine months.

“If we accept credit at a higher cost, we will have a hard time paying it in the years to come,” added the executive.

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