Liquidity pressures are pushing more of China's local government financing vehicles (LGFVs) to tap offshore renminbi debt markets. This is a markedly more expensive channel than domestic issuance. Going offshore therefore highlights the increasing difficulty that the LGFVs face in financing or refinancing at home.
The cost differential is widening. Coupons in the offshore renminbi (widely known as CNH) market exceed 5% on average. In contrast, average bond coupons in the domestic market are declining, at below 3% (see chart).
Chart 1
What's Happening
Offshore issuance is dominated by LGFVs from five provinces. In the first eight months of this year, LGFVs from Shandong, Fujian, Hubei, Sichuan, and Henan have issued CNH bonds amounting to Chinese renminbi (RMB) 70 billion. This is a fourfold increase from the same period last year. The LGFVs' bonds represent two-thirds of the LGFV sector's total CNH issuance, up from only a third in 2023.
As of August 2024, some 222 LGFVs have issued CNH bonds, compared with 3,000 LGFVs that have issued in the domestic bond markets. Domestic issuance involves more restrictions on the use of proceeds, with most primarily used for refinancing.
Why It Matters
Some LGFVs have little alternative. In our view, LGFVs in the five provinces mentioned above can't meet a growing portion of their financing and refinancing needs in the domestic market. CNH issuance has been surging because the LGFVs need more flexibility over the use of funds, notably for interest repayment and new investments.
The central government has not included the five provinces in its category of 12 "highly indebted" provinces, which have special policies around resolving their debts. But LGFVs from the five provinces--and others like them--still face financing challenges of their own.
Conversely, LGFVs in more affluent provinces continue to favor issuance in domestic markets, given the consistently competitive borrowing rates.
Regulations are tightening. Nonstandard debt and the appetite of domestic creditors are constrained due to the stricter regulations. Authorities are also tightening approvals for LGFVs to issue offshore U.S. dollar notes (see "China LGFVs Face Higher Liquidity Risks As Funding Channels Tighten," published on RatingsDirect on Jan. 10, 2024).
The 12 highly indebted provinces are subject to strict fiscal controls. Their LGFVs are increasingly refinancing maturing high-cost debt through large state-owned banks to repair their capital structures with longer and cheaper loans or restricted domestic bonds.
What's Next
Temporary liquidity relief won't resolve the debt burden. The steep coupons for CNH bonds will add to the issuing LGFVs' repayment pressure, creating another problem. It also goes against China's policy direction, which includes urging LGFVs to repay offshore maturities using onshore issuances.
Divergence of coupon rates suggests the offshore market has insufficient depth. Despite the rush of issuers, creditors may have limited capacity to subscribe, leading the pricing differential to become even wider.
Issuers from more affluent provinces are already holding off. As an example, the CNH issuance of Zhejiang's LGFVs amounted to just RMB5.8 billion in the first eight months of 2024, compared with a peak of RMB32.8 billion in the previous 12 months. We believe the risk profiles of issuers may continue to shift.
LGFVs' financing conditions will remain uneven. Some LGFVs that aren't located in the 12 highly indebted provinces may continue to have trouble with financing. Alternative financing or refinancing channels will be critical to keep many of the weak LGFVs afloat, in the same way that nonstandard debt has helped in the past.
The debt resolution of the 12 highly indebted provinces will remain under the close scrutiny of local governments and policy banks. And more affluent regions should still have stable funding access. But the financing gap could widen for the regions in between.
Related Research
- Your Three Minutes In China's LGFV Debt Resolution: Buying Time Is Buying Bad Habits, Sept. 5, 2024
- Your Three Minutes In Panda Bonds: Why Issuance Is Surging, Aug. 7, 2024
- Credit FAQ: Is It Working? China's LGFV Debt De-Risk Program One Year On, July 25, 2024
- Your Three Minutes In China LGFV Bonds: Weaker Entities Go Long, June 27, 2024
- Record Bond Rejections To Squeeze China's Lower-Tier LGFVs, April 11, 2024
- China LGFVs' Bigger Housing Role: Risk Control Matters, March 26, 2024
- Same Game, Different Name: China LGFV Issues To Repay The Debt Of A Peer, Feb. 28, 2024
- China Policy Shift May Saddle LGFVs With A Fresh Problem: Stranded Assets, Jan. 25, 2024
- China LGFVs Face Higher Liquidity Risks As Funding Channels Tighten, Jan. 10, 2024
This report does not constitute a rating action.
| Primary Credit Analysts: | Kendrew Fung, Hong Kong + 852 2533 3540; kendrew.fung@spglobal.com |
| Laura C Li, CFA, Hong Kong + 852 2533 3583; laura.li@spglobal.com | |
| Secondary Contact: | Christopher Yip, Hong Kong + 852 2533 3593; christopher.yip@spglobal.com |
| Research Assistants: | Tiani Li, Hong Kong |
| Harry Yuan, Hong Kong |
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