China’s government has a creative solution to address repayment concerns hanging over more than $3 trillion in regional debt. It will deal with it later.

The Finance Ministry issued a 1 trillion yuan ($160 billion) quota for local governments to convert maturing high- cost debt into lower-yielding municipal notes to be repaid at a future date, according to a March 8 statement. Questions left unanswered include whether investors will be forced into the swap, how much transparency there will be over assets involved and whether the liabilities will strain the nation’s finances.

China’s bond risk rose the most in a month on March 9 even as debt-rating companies welcomed the government’s plan to address regional debt, which Mizuho Securities Asia Ltd. estimates may have reached 25 trillion yuan, bigger than German’s economy. The ministry’s 500 billion yuan municipal bond trial and the auction of 100 billion yuan of special bonds is insufficient to meet local-government financing vehicle debt due this year while funding budgets, Moody’s Investors Service said.

 “It will buy time for the government to solve the local debt problem, as the transition period takes three to five years,” said Ivan Chung, a senior vice president at Moody’s in Hong Kong. 

?“The 1 trillion yuan debt-swap plan will be able to cover the refinancing needs of the maturing bonds this year, as municipal bond issuance is not enough.”

Eoin Treacy's view

The Chinese know better than we do that the trajectory of local government debt is unsustainable. Let’s focus then on the potential solutions to the problem rather that rehash the bearish arguments. Extending the maturity of debt by rolling it over into longer maturity, less expensive alternatives is a partial fix but does not help with the issue of how local governments can hope to finance their ongoing operations. 

The national register of property ownership currently underway is due to be completed within 18 months. This is the preamble to a nationwide property tax which will significantly improve the financial position of the municipal sector. Even more important, from a governance standpoint, the creation of a local property tax system will free local governments from the requirement for land sales and therefore development. It is can be seen as a positive development that the administration is willing to assist in the rollover of maturing debt because it reduces the possibility of an unruly solution. 

The CSI 300 Index continues to consolidate its late 2014 rally but a sustained move below the 200-day MA would be required to question medium-term scope for additional upside. 

The US Dollar’s strength and potential for interest rates to rise later this year are acting as headwinds for Hong Kong with its pegged currency system. The H-share Index of Hong Kong listed mainland companies has returned to test the region of the 200-day MA and will need to find support within the next 500 points if medium-term scope for additional higher to lateral ranging is be given the benefit of the doubt.