China’s LGFV defaults may have a wider impact

Sellside individuals say LGFV defaults could spell trouble for the onshore bond market

China's local government finance vehicles (LGFV) are rattling fixed income investors, with some sellside players thinking that recent defaults could spell trouble for the whole onshore bond market. As the default on a loan repayment by a Tianjin associated LGFV in April prompts scrutiny of the near US$600 billion market, Asset Benchmark Research canvassed the views of more than 250 sellside analysts across Asia.

Respondents said that the defaults, including the technical default in January 2018 by another LGFV in Yunnan, come amid the onshore bond market opening up to international investors. "The LGFV default will cause a market sell-off," said a salesperson in Singapore covering CNY. A salesperson in China foresees a "repricing of the whole bond market".

Credit spreads are set to widen. "For years, LGFV bonds have attracted investors because local or central governments will always be prepared for a bailout. However, if LGFVs are free to default, the market's faith in LGFV bonds will be affected. The yield on LGFV bonds will increase rapidly and the negative sentiment for LGFV bonds will spread across the whole market," said another salesperson in China.

While some respondents foresee a big impact, others pencil in only a limited impact. "China is an important market but LGFV moves will mainly impact the onshore market," said a salesperson in Hong Kong. Another trader in China said that the market has already priced in the recent defaults, so the LGFV situation will be regarded as normal. "We think that the defaults will not have a significant negative impact on the market because the LGFV sector sports a low correlation with the sovereign sector," said another salesperson in China. "LGFVs, together with real estate, are monitored by regulators and the risks are well known."

Some sellside players see a silver lining for other asset classes. While demand for LGFV bonds may fall, other high yield assets could benefit. A multi-market salesperson in Singapore said: "I expect LGFV defaults to reverse the development of the onshore bond market as private banking money will go more into equities, private equity and other alternative markets."


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23 May 2018


Capital Markets

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