Crisis gauges fall as Li seen limiting default fallout


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Premier Li Keqiang has announced stimulus measures as an economic downturn threatens the ability of regional governments and companies to repay existing debt. 

China’s credit-market gauges show improving risk appetite as the government demonstrates its ability to limit fallout on banks and the economy from defaults.
The spread between the two-year sovereign yield and the similar-maturity interbank interest-rate swap, a gauge of financial stress, narrowed 71 basis points this month to 14 basis points on April 23. It reached 121 basis points on Feb. 19, the widest in Bloomberg data going back to 2007. The yield premium of five-year AA rated debt, the most common grade for local-government financing vehicles, over top-rated notes fell to a four-month low of 121 basis points on April 23.
While Premier Li Keqiang’s government allowed privately-owned Shanghai Chaori Solar Energy Science & Technology Co. (002506) to become the first onshore bond issuer to default in March, it has sought to curb more damaging failures. Policy makers announced plans to ease pressure on LGFVs by funding urban projects with private capital and municipal notes. The eleventh-hour rescue in January of a 3 billion-yuan ($481 million) product arranged by China Credit Trust Co. gave regulators time to introduce tighter rules on shadow banking.
“The fear earlier this year that credit events could have wider impact on the economy or the financial system has waned,” Liu Changjiang, a Shanghai-based fixed-income analyst at Essence Securities Co., said on April 23. “The market almost has the consensus that the LGFV bonds are safe, and as they can offer high yields, why not put money there?”
Sales jump
The yield on two-year sovereign notes increased 32 basis points this month to 3.73 percent on April 23, heading for the biggest monthly gain since August 2012. The rate declined 93 basis points in the three months ended March 31, the biggest quarterly drop since the 2008 financial crisis. The yield for AA bonds slid 31 basis points in April to 6.35 percent.
As demand improved for riskier debt, sales of LGFV paper surged to 104.7 billion yuan in April, the highest since March 2013, according to China Chengxin International Credit Rating Co. That has more than tripled from 30.6 billion yuan in January. The yield on Tieling Public Assets Investment & Management Co.’s seven-year notes plunged 109 basis points since Jan. 31 to 6.20 percent yesterday, exchange data show.
“You can tell investors have risk appetite because yields on the secondary market declined even as huge new supplies are coming up,” Liu said. “People have simply ditched the safe, short-tenor sovereign notes.”
Economic slowdown
Premier Li Keqiang has announced stimulus measures as an economic downturn threatens the ability of regional governments and companies to repay existing debt. Gross domestic product expanded 7.4 percent in the first quarter, below the target of 7.5 percent this year, while the broadest measure of new credit declined 19 percent in March from a year earlier. A survey of purchasing managers has shown contraction for four consecutive months.
The People’s Bank of China reduced reserve-requirement ratios for county-level rural commercial banks and cooperatives this week, following targeted stimulus policies from railway investments to tax relief.
“The government is facing a big challenge to curtail debt increases, and at the same time maintain the growth rate above 7 percent,” said Wang Ming, marketing director at Shanghai Yaozhi Asset Management LLP, which oversees 2 billion yuan of fixed-income assets. “The LGFV debt problem will be exposed when the growth slows. After all, many have serious cash flow problems. Yields on LGFV bonds are under pressure to rise.”
Yield curve
The yuan is still reflecting concerns over the slowdown, touching 6.2509 per dollar yesterday, the lowest level in 16 months, China Foreign Exchange Trading System prices show. The currency is down 3 percent in 2014, the worst performer in Asia, after rising for four consecutive years.
Ten-year sovereign debt has rallied on expectations a slowing economy will curb inflation. The benchmark yield is heading for the biggest monthly drop since May 2012, losing 17 basis points, or 0.17 percentage point, to 4.33 percent on April 23, according to ChinaBond data. The spread over two-year notes narrowed 49 basis points on March 31, set for the biggest monthly drop since Bloomberg started compiling the data in 2007. The comparable spreads are 50 basis points in Brazil and 225 basis points in the U.S.
“Premier Li obviously doesn’t want to use large-scale stimulus policies that would dramatically increase money supply and credit growth,” said Yang Feng, a Beijing-based fixed-income analyst at Citic Securities Co. “However, it remains a question whether the targeted stimulus policies so far will be able to drag the economy out of the woods.”
Municipal bonds
The government is seeking to curb further failures. The banking regulator ordered owners of the nation’s 68 trust companies to prepare to provide funding or sell stakes when they face liquidity constraints. It also limited their entry into new businesses and products, according to an April 8 notice seen by Bloomberg News.
The National People’s Congress has proposed granting the governments of provinces, the four municipalities and autonomous regions the right to issue bonds directly, China News Service reported on April 21. A State Council meeting on April 24 decided to open 80 projects in industries dominated by state-owned enterprises for public tender and investments from private capital, according to a government website.
“The two changes will both reduce risks in LGFVs in the long run,” said Xu Hanfei, a fixed-income analyst at Guotai Junan Securities Co. in Shanghai. “The introduction of municipal bonds will help control the growth in LGFV bonds in the future, and letting private capital participate in infrastructure construction should improve profitability.”

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