The depreciation of the Chinese yuan is slowing down offshore bond issuance by Chinese local government financing vehicles (LGFVs), Fitch Ratings says. However, offshore bond issuance by LGFVs will not halt entirely because they would still need to diversify their funding channels while some local governments use debt issuance as an opportunity to promote their regions overseas.

LGFVs' high and rising debt burden has been eased after Chinese authorities lowered domestic interest rates and implemented a programme that allows LGFVs to swap higher-cost debt for lower-cost bonds. However, the lower rates have driven capital outflows from China, which may further weaken the yuan.

If the Chinese currency keeps depreciating, LGFVs' offshore debt servicing costs will continue to rise as they pay more in local-currency terms. The impact will be largest on debt denominated in the US dollar, which has appreciated sharply against the yuan and accounts for the majority of LGFVs' offshore debt.

However, the overall impact of the sliding yuan on LGFVs is still manageable because foreign-currency debt forms only a small portion of their total debt - the ratio was less than 10% for Fitch-rated Chinese LGFVs.

Fitch expects some LGFVs to continue issuing debt in US dollars to diversify from the domestic bond market. Moreover, local governments often use the issuance of an offshore bond to raise their profiles in international capital markets and to promote the region to external investors.

Large, provincial-level LGFVs with strong sponsors are likely to be more cautious about raising funds offshore because there is no longer the advantage of lower costs compared with domestic funding. We expect more lower-tier LGFVs to debut in the US dollar bond market with smaller issuance size, either to promote the local economy or to seek alternative funding when faced borrowing restrictions onshore.

Most LGFVs' standalone credit profiles and cash generation capabilities are low because of their public-sector obligations. The creditworthiness of the sponsor to which the LGFV is credit-linked and the strength of the linkage between the entity and the sponsor are the key factors that would affect an issuer's credit profile.