Bond bonanza

"They bought our bonds!"

Amidst high default rates, punitive credit ratings and unprecedented funding costs in large parts of the world’s municipal bond markets, you will probably be surprised to hear that – despite the less than perfect timing – two of China’s poorest provinces have recently issued the first muni-bonds of their own.

Beijing is pushing forward its plan to sell Rmb200 billion worth of municipal bonds. The pioneer provinces, Xinjiang and Anhui, have successfully raised Rmb7 billion. The Xinjiang Uygur Autonomous Region, as it is known, auctioned Rmb3 billion ($438 million) worth of three-year municipal bonds last Friday. The issue was oversubscribed by 2.07 times thanks to the strong backing of Beijing. Meanwhile, the coupon came in at the bottom end of the market’s expectations at just 1.60%. Anhui, the second to issue local debt, auctioned off Rmb4 billion worth of three-year bonds this Tuesday, also at a coupon of 1.60%.

The money, according to the Ministry of Finance, will be used locally to finance the country’s Rmb4 trillion ($586 billion) stimulus plan, which includes building affordable homes, improving infrastructure in rural areas, healthcare spending and rebuilding earthquake-hit regions.

Indeed, the issuance of the muni-bonds will help relieve some of the financial pressure on the local government. Although Beijing has been vague about how much of the Rmb4 trillion will come from the local government’s pocket, the consensus is that central government will fund only Rmb1.18 trillion, with the rest to be shared between local governments, bank loans and corporate bonds.

Money is getting tight at the municipal level. China’s tax system funnels most revenue centrally, to Beijing. For instance, for local corporate income taxes, 60% goes to the central government and 40% to locals; value-added taxes split 75% and 25%. Until recently, local governments relied heavily on leased land and real estate sales to make ends meet. But, with land sales slowing significantly, local government revenues have dived further than an Italian footballer in the penalty area. The introduction of municipal bonds has offered a new source of liquidity for some of the more cash-strapped local governments.

To entice investors, interest income from the bond will be tax-exempt. China currently charges personal income tax of 5% on interest income from all fixed-income instruments except central government bonds. The municipal-bond programme is tightly controlled by Beijing, to discourage reckless borrowing and slack financial management (not to mention corruption). Under the current framework, the Xinjiang bond is sold by the Ministry of Finance on behalf of the local government. The ministry pays the principal and interest on the bonds to investors on behalf of the local governments after the debt matures. The local government, in turn, will repay the ministry.

The situation in China contrasts starkly with the US, where many states have been able to run up huge debts beyond the control of the federal government. When designing its own municipal bond programme, Beijing probably had this issue – and particularly the state of California – very firmly in mind.

However, depending on the financial need of the provinces, some will be granted a bigger quota for municipal bond issues, says Southern Weekend. Sichuan, for instance, is being allowed to raise the most – Rmb18 billion – but that’s because so much of the province needs rebuilding after last May’s earthquake. Meanwhile, Beijing, which is more affluent, is only allowed to raise Rmb5.6 billion.

The government has not provided a timetable for the specific debt auctions, but the first two debt issues seems to suggest that it has given the green light for new funding to flow to China’s poorer and less-developed inland areas first.

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