This report does not constitute a rating action.
Key Takeaways
- Shenzhen's first-ever offshore renminbi bond will likely widen financing channels for other Chinese local governments.
- We see this move as in line with China's reforms to improve the murky financing habits of local and regional governments (LRGs).
- China's subnational debt market is the world's second largest, just six years after launching, and will continue to grow.
China is set to issue its first-ever offshore subnational bond. S&P Global Ratings believes a successful transaction could forge new financing channels for other local and regional governments (LRGs).
On Oct. 11, 2021, the Shenzhen municipal government announced its coming issuance of three tranches of offshore renminbi notes, raising Chinese renminbi (RMB) 5 billion (US$772 million). The three-year senior unsecured bonds will list on the Hong Kong stock exchange. Meanwhile another LRG--the Guangdong provincial government--also indicated its plans to issue offshore notes to raise RMB2.2 billion, and list them on the Macau stock exchange.
In our view, an offshore market for subnational bonds could deepen financing options for China's LRGs, which undertake the lion's share of public spending in the country. It could also increase transparency, as it moves LRGs farther away from a model of borrowing indirectly through incorporated arms.
The World's Second Largest "Muni" Market
We expect China's LRGs will remain large borrowers, to sustain their critical role of facilitating LRGs' public finance activities. The LRG sector has typically accounted for about 85% of the operating spending of China's general governments, i.e., including both central and local government spending. Moreover, the LRG share of capital spending rose to 98% for 2020, due to COVID-19 challenges.
Subnational debt issuance has grown rapidly since China deregulated to allow all tier-one LRGs to issue debt under their own names in 2015 (see chart 1) The reported debt stock for LRG bonds was RMB28.5 trillion (US$4.4 trillion) as of Aug. 31, 2021. This is largest subnational debt stock in the world, excepting the U.S.
Chart 1
Subnational debt issuance would be the last major Chinese asset niche to go offshore, after corporates, financial institutions, and sovereign sectors.
China's LRGs have indirectly tapped offshore markets through the corporate arms they control, raising funds that are generally off-budget. Direct issuance under LRGs' names was introduced in 2015 to bring more transparency to local-government financing. At this juncture, only tier-one governments--such as provinces, big cities or special economic zones like Shenzhen--can issue subnational bonds.
More Transparency For A Relatively Murky Sector
Besides opening up another channel for direct municipal bond-style issuance, the terms and conditions of Shenzhen's planned debt further clarify contractual risks of bonds issued by Shenzhen and other LRGs. We expect most outstanding issuances (onshore and offshore) by Chinese LRGs shall rank equally with their other senior unsecured subnational bonds. We therefore can largely align issue repayment risks with the creditworthiness of underlying LRGs as the issuers.
Government resources are generally fungible to fulfill debt repayments across different financial obligations at the LRG level or the issuing entity. There are mainly two types of asset classes issued directly by local LRGs: general bonds and special bonds. General bonds are mainly associated with an LRG's operating activities, while special bonds for capital activities.
We do not think that special bonds face higher repayment risk than general bonds--a question we often get form investors, given they're kept under different budget accounts. In our view, LRGs manage multiple government accounts to clarify spending responsibilities.
Most LRGs control sizable and valuable assets. We believe these resources are fungible, meaning they can support debt repayments even upon shortages of operating cash flows for any budget accounts. China's legal framework allows LRGs to liquidate assets for bond repayment when necessary. In addition, we believe the central government would provide exceptional support to LRGs for debt repayment when necessary.
While improving, we continue to view transparency risks as one weakness of Chinese LRGs. Shenzhen's disclosures in its offshore issuance documents are basic by international standards. For example, no LRGs in China opt to disclose details of their liquidity and debt profiles.
An Asset Class That Is Evolving As It Grows
Even as China's LRGs are increasingly borrowing in a direct manner--instead of through its corporate arms--these governments remain exposed to the state-owned companies they control. We view interpretation as a key information challenge when trying to identify government-related entity (GRE) risks. A lack of clarity persists regarding how GREs fit into LRG's fiscal policy.
We view GRE activities as evolving, with the central government pushing for their migration to commercial activities while LRGs continue to depend on these companies (especially key GREs) to execute infrastructure development. Most LRGs remain exposed to the excessive debt accumulation by GREs, which have aggregated debt that we estimate at around half of China's GDP or 200% of the total revenues of the LRG sector.
We view the creditworthiness of Chinese tier-one LRGs as generally stronger than other tiers of government in China but unlikely to be above that of the sovereign (A+/Stable/A-1). Chinese tier-one LRGs operate in a stable public finance system, which is increasingly tied to acentralized policy direction. Chinese tier-one LRGs remain highly dependant on central government transfers, while their spending plans are closely tied with China's public finance agenda.
Related Research
- Institutional Framework Assessment: China Provincial Governments, Aug. 31, 2021
- Institutional Framework Assessment On China's Local Governments Raised On Central Government's Tightening Control, Aug. 29, 2021
- China Provincial Governments' Risk Indicators, June 16, 2021
- Local Government Debt 2021: Global Borrowing To Hit $2.25 Trillion, March 25, 2021
- China LRGs In Focus: Shenzhen City, Dec. 15, 2020
This report does not constitute a rating action.
| Primary Credit Analyst: | Susan Chu, Hong Kong (852) 2912-3055; susan.chu@spglobal.com |
| Secondary Contact: | Felix Ejgel, London + 44 20 7176 6780; felix.ejgel@spglobal.com |
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