BEIJING (Reuters) – China could see the first default on a bond issued by a local government financing vehicle (LGFV) this year, S&P Global Indices said in a report on Tuesday.
China is in the second year of a campaign to reduce risks from a rapid-build up in debt and riskier types of financing.
The clampdown has led to tighter credit conditions, slowly rising borrowing costs and greater scrutiny of local government spending, with weaker debt issuers finding it more difficult to access financing.
S&P said it expects rising corporate earnings in 2018 to allow for more deleveraging, though weaker firms could struggle as regulators tighten restrictions on alternative financing channels, or shadow banking. As a result, defaults should also rise, albeit from a low base.
“Regulators are taking advantage of continued economic reflation to shut down backdoor funding channels and hold Chinese companies to more disciplined financial standards,” S&P said.
S&P said its overall outlook on Chinese issuers is more neutral this year after a strong negative bias last year, and even though it sees defaults rising this year, it would be up from only one default of a rated issuer in 2017.
S&P expects moderate improvement in debt ratios at Chinese firms from 2018-2019 due to the impact of the deleveraging campaign, slower infrastructure investment and a property slowdown.
Local government finances and burgeoning debt levels in China have been a source of concern for as the central government looks to remove expectations of implicit guarantees for government financing vehicles.
An official at the People’s Bank of China in a December editorial wrote that China needs to let local governments take responsibility for their finances, including allowing bankruptcies, as part of an effort to defuse their debt risks.
“(LGFVs’) implicit support by their respective governments will be tested, given the central government’s renewed efforts to reduce financial risks of runaway local government debt growth,” S&P said in its report.
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