Special Bond Issuance Set to Peak in September, MOF to Demand 40 BP Premium

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Beijing’s latest call for the accelerated issuance of special bonds by Chinese local governments in the second half is expected to lead to a surge in supply over the next several months.

On 14 August China’s Ministry of Finance (MOF) issued the “Opinions Concerning Properly Performing Local Government Special Bond Issuance” (关于做好地方政府专项债券发行工作的意见), which outlined a sharp acceleration in special bond issuance prior to the end of the year.

The Opinions mandate that “by the end of September the percentage of new special bonds issued cannot in principle comprise less than 80% [of the annual quota], and the remaining issuance quota should mainly be issued in October.”

Funds raised by Chinese local governments via special bonds are mainly used for shantytown upgrades, public roads and other infrastructure investment projects.

MOF has set an annual target for the issuance of new local government special bonds in 2018 of 1.35 trillion yuan.

Su Jinhe (苏锦河), an analyst with China Bond Rating, said to 21st Century Business Herald that 150.3 billion yuan in new special bonds were issued in the first seven months of 2018 .

Based on the target dates and quotas outlined by the Opinions, Su said that 1.08 trillion yuan in new special bonds will need to be issued by the end of September, which means an issuance volume of 930 billion yuan in the months of August and September alone.

Given the imminent spike in the supply of local government special bonds, sources said to 21st Century Business Herald MOF is likely to require that local governments set rates for special bonds at around 40 basis points above the rates for Chinese sovereign bonds of the commensurate maturity.

“Previously, the issuance of local government bonds wasn’t market-based at all,” said one source at a Beijing-based brokerage, pointing to extremely small spreads between the rates for bonds issued by different local governments around China.

The sources said that local governments in China often apportion bonds to local banks, before “demanding that they purchase them, otherwise they won’t be able to wet their beaks with fiscal deposits or business from local government.”

Another source from a joint-stock bank said that banks were not very willing to buy local government debt due to the controls imposed upon yields.

“Usually it’s local government applying pressure to local branches, who then apply pressure to the head office.”

The source said that it is highly necessary for MOF to demand increases in the rates for local government bonds, in order to strengthen the willingness of banks to purchase them and ensure the smooth passage of the issuance peak, while also raising the appeal of local government bonds to non-bank financial institutions.

As a result of the surge in special bond issuance Su Jinhe expects the supply of rates securities in China to exceed 2 trillion yuan during the August-September period.

“Despite funds amongst banks being quite loose at present, this looseness is only due to interbank CD’s or interbank deposits,” said Su.

“The decline in deposit rates, which are the biggest part of bank liabilities, hasn’t been large at all, and for this reason allocating costly funds from deposits to rates securities is of limited appeal to banks.

“If non-bank institutions are not sufficiently motivated to purchase, and the central bank does not continue to release liquidity, then there will will be considerable supply pressure for rates securities in August and September.”

 

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