Debt investors should watch China’s east-west divide

Bond investors, beware: the Middle Kingdom is splitting in two.

International investors are increasingly drawn to Chinese debt markets, the third largest in the world behind the United States and Japan, as issuances skyrocket and central government bonds begin to be included in debt markets. global benchmarks. But any fund manager who ventures beyond these safest assets should consult a map before diving into provincial government debt.

It is not uncommon for local governments to run large deficits in China. The latest official figures show that only the wealthy urban municipalities of Beijing and Shanghai posted a funding surplus in 2017. Revenues collected by the other 29 provincial governments fell short of spending.

But Moody’s, the credit rating agency, has found that regional differences between provincial funding spreads are widening. Where governments in the eastern provinces faced an average shortfall of 27 percent relative to spending, those in central and western China experienced average deviations of 50 and 77 percent, respectively.

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Much of the additional spending in the west is intentional: China’s central government in Beijing has sought to iron out regional inequalities by encouraging large infrastructure projects, for example. But Amanda Du, senior analyst for sub-sovereign debt at Moody’s Investors Service, said differences between regions had worsened since 2015 and are expected to widen further.

Since interior provincial governments already have a higher debt burden compared to previous spending rounds, she said, their ability to issue other bonds was limited. Instead, they would continue to use non-accountable funds raised largely through special fundraising vehicles. This has the effect of accumulating more risk.

“As long as they have this gap, they will have to rely on off-balance sheet funding channels,” Ms. Du said.

The result is that international debt investors may need to learn the difference between Shanxi and Shaanxi provinces. The former has a funding gap equal to about 20 percent of its total revenues. Neighboring Shaanxi to the west has a 130 percent gap.

Carol M. Barragan

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