Bonds on the Bund

Not a big fan of welfare: Jin Liqun

Does anyone have any idea how to solve the Eurozone crisis? Not yet, by the look of it. But at least Jin Liqun sounds confident in diagnosing the causes of the current Euro malaise. In fact, just one cause will do for Jin. “If you look at the troubles which happened in European countries, this is purely because of the accumulated troubles of the worn out welfare state,” the chairman of the board of supervisors at sovereign wealth fund CIC, told Al-Jazeera in an interview.

In that case, Jin might want to keep an eye on what’s been happening in Shanghai, which recently issued Rmb7.1 billion worth of bonds to pay for a wide range of projects aimed at improving the welfare of the city’s population.

Nearly one third of the proceeds will be used to pay for affordable housing, reports the 21CN Business Herald, with much of the the remaining proceeds funding spending in healthcare and education.

The bond is another step in a major financial reform, with Shanghai the first city government to issue bonds itself in China since the early 1990s.

The debt was sold in two tranches: Rmb3.6 billion of three-year bonds with a 3.1% yield, and Rmb3.5 billion of five-year bonds with a 3.3% yield. Both bonds were more than three times subscribed, reports Xinhua. Two of China’s richest provinces, Guangdong and Zhejiang, have also sold bonds worth Rmb6.9 billion and Rmb6.7 billion respectively.

The plan is that these bonds will help resolve systemic problems relating to local government debt. Over the last few years, cities and provinces have borrowed heavily from banks to fund infrastructure projects (see WiC110). Now markets are waiting to see just how much of the debt is going to default. Standard & Poor’s predicts that as much as 30% of lending could go bad (some has already, see WiC113).

Bonds are supposed to address some of this uncertainty. In theory, a rigorous debt capital market should allow for a more transparent system that will keep borrowing within reasonable limits. Proceeds from the bonds could also help plug funding gaps opened up by a slowing property market (and falling revenues from land sales). Shanghai has already been hit by this trend. By the end of October, the local government had raised Rmb105.6 billion transferring title to 2,305 hectares of land, reports International Financial News. But compared to last year, authorities have sold 9% more land for 23% less cash.

Still, don’t expect to see an independent municipal bond market appear overnight. The scheme is still in pilot format and is being heavily scrutinised by the central government in Beijing, which has also placed restrictions on how much money is raised. Additionally, the Ministry of Finance will pay the debt obligations out of funds providedfrom local government coffers.

For investors that is a positive, and taken as a sign that the central government is guaranteeing the debt. Hence the way that some of the bonds have begun trading has been a surprise. The three-year bonds issued by Zhejiang trade 14bps inside the comparable Ministry of Finance bond, with the Shanghai and Guangdong bonds also trading through Ministry of Finance debt, suggesting that local governments are regarded as more creditworthy than their master.

As HSBC analyst Zhang Zhiming puts it, this appears to “defy logic based either on credit profile or liquidity”. Banks may be willing to buy into the deals at cheap rates as long as the proceeds of the bond are deposited by the local governments with them, says Zhang, because they have suffered a significant drop in deposits and are looking at ways to attract funds.

How long this mispricing can last is anyone’s guess. But bureaucrats at the Ministry of Finance might be feeling a little sore that Shanghai can currently borrow cheaper than China itself…

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