Moody's: China's tightened supervision of enterprise bonds will restrict credit for infrastructure projects

Moody's Investors Service says that the Chinese government's (A1 stable) move to tighten supervision on the issuance of enterprise bonds by local government financing vehicles (LGFVs) enhances transparency around the contingent liabilities of regional and local governments (RLGs), but also restricts credit for infrastructure projects.

"The guidelines further increase transparency and governance around direct debt and contingent liabilities, and also rein in enterprise bond issuance by LGFVs," says Amanda Du, a Moody's Vice President and Senior Analyst.

"However, LGFVs have been key funding platforms for RLGs' infrastructure spending, and the new restrictions mean the associated liabilities will likely shift back to RLGs or other state-owned enterprises (SOEs)," adds Du.

Moody's views this shifting of liabilities as a product of the policy trade-offs that the Chinese authorities face in achieving deleveraging while maintaining economic growth drivers.

Moody's analysis is contained in its just-released report titled "Regional and Local Governments — China: Tighter control of enterprise bonds will restrict credit for infrastructure projects," and is authored by Du.

The new guidelines -- contained in so-called Document 1358 issued by the China National Development and Reform Commission (NDRC) on 15 August -- spell out for the first time the major approval criteria for enterprise bond issuances that are related to RLGs' contingent liabilities. Consequently, the guidelines should help control growth in such liabilities.

"The guidelines are credit negative for LGFVs because only a small number of LGFVs under upper-tier RLGs will continue to receive high levels of government support, thereby raising concerns over the refinancing and liquidity risk that the LGFVs face," says Du.

Moody's explains that the guidelines highlight the importance of enterprise bonds in supporting China's economic development, and especially national strategic goals such as the Belt & Road initiative, as well as the integration of Beijing, Tianjin and Hebei. The guidelines therefore reinforce Moody's opinion that support by RLGs to LGFVs will continue to vary.

Moody's report says that only a small number of LGFVs will likely continue to receive high levels of government support, namely those that: (1) are characterized by their unique role in national projects with strategic importance; or (2) show substantial exposures in the credit market, such that if they should default, they are more likely to trigger systemic risk.

At 30 June 2017, the outstanding amount of enterprise bonds issued by LGFVs totaled RMB2.4 trillion ($354 billion), accounting for 76.5% of all outstanding enterprise bonds.

Document 1358 reiterates the separation of credit links between enterprise bond issuers and their respective RLG owners, and prohibits RLGs from providing direct support to the enterprise bonds issued by LGFVs in all circumstances except the most extreme cases.