Budget Strains Showing as S&P Warns on Local Debt: China Credit

May 06, 2014 9:55 pm ET

May 7 (Bloomberg) -- China’s cooling property market has helped push its budget into deficit and prompted Standard & Poor’s to warn of risks to the finances of regional borrowers.

Growth in national fiscal revenue slowed to 5.2 percent in March from 8.2 percent in February, Ministry of Finance data showed. The budget swung to a 326 billion yuan ($52 billion) deficit from a 257.5 billion yuan surplus. New home sales in 54 cities tracked by Centaline Group slid 47 percent from a year earlier to a four-year low over the May 1-3 Labor Day holidays.

Property market weakness would undermine Premier Li Keqiang’s efforts to spur growth and make it harder for local- government financing vehicles to repay debt using land sales. Borrowing costs for companies with an AA rating, the most common for LGFVs, have dropped 75 basis points this year, helping spur a 40 percent increase in bond sales.

“A significant deterioration in the property market and land prices will have very wide-ranging implications for the entire economy and also credit markets,” Christopher Lee, head of corporate ratings for Greater China at S&P in Hong Kong, said in a May 5 e-mail interview. “Land is used as the collateral for financing for LGFVs. It’s also used as the collateral for property developers to get construction funding.”

Local governments have set up thousands of financing vehicles to fund projects from subways to sewage systems, which account for 80 percent of state capital spending and 40 percent of tax revenue, the World Bank estimates. Total liabilities of regional authorities rose to a record 17.9 trillion yuan as of June 2013, the National Audit Office estimates.

Fiscal Income

Land sales in 20 major cities in March fell 5 percent from a year earlier, the biggest drop in at least a year, according to China Real Estate Information Corp. data compiled by Bloomberg. The value of sales in third-tier cities declined 27 percent last month, according to Soufun Holdings Ltd., the nation’s biggest real estate website owner.

Gross domestic product increased 7.4 percent in the first quarter from a year earlier, the least since the first three months of 2009 and less than the government’s full-year target of 7.5 percent, official data show. Fixed-asset investments rose 17.6 percent in March, the slowest pace since 2002.

To spur growth, the State Council has outlined a package of spending on railways and shantytown redevelopment, and expanded tax relief for micro-enterprises and exporters. Premier Li also plans to set up a transparent financing mechanism for city construction that will allow local governments to sell municipal bonds directly, according to an urbanization plan for 2014-2020 released in March.

Tighter Financing

“Infrastructure spending is funded by proceeds from land sales, which in turn are affected by the housing market,” Goldman Sachs Group Inc. analysts Li Cui and Maggie Wei in Hong Kong wrote in a April 17 research note. “All else equal, the housing slowdown tends to tighten the financing of fiscal spending.”

Land sales account for almost 30 percent of total government revenue, Goldman estimated in the note. Some cities plan to reverse controls implemented to make home prices more affordable or give residency benefits to out-of-town buyers, a state-run newspaper reported this week.

“Certainly the current system is still working, and people don’t see an imminent meltdown,” Wang Ming, marketing director at Shanghai Yaozhi Asset Management LLP in the city, said in an interview yesterday. “However, it will take some time for policy makers to reach a consensus on how they plan to change the fiscal system to cater to the next stage of development in China.”

‘More Pressure’

The country’s sovereign bonds have advanced this year, with the benchmark 10-year yield falling 25 basis points to 4.30 percent, according to data from the National Interbank Funding Center. The yuan slid 2.8 percent to 6.2257 per dollar, the worst performance among Asia’s 11 most-traded currencies, China Foreign Exchange Trading System prices show.

The biggest risk to Asia’s largest economy lies in the impact of an economic downturn on the real estate market and LGFVs, so the government’s deleverage push should take it into consideration, Xu Nuojin, deputy head of the statistics department at the central bank, wrote in an article in the China Securities Journal published April 27.

Chinese property developers raised 49 percent less through trusts in the first quarter from the preceding three months, data compiled by Use Trust showed. There will be more defaults by small developers, following the collapse of Zhejiang Xingrun Real Estate Co. in March, according to S&P.

“The question is no longer if or when, but rather how much China’s property market will correct,” Nomura Holdings Inc. economists led by Zhang Zhiwei in Hong Kong wrote in an April 29 research note. “Local governments are likely to be under even more pressure to help the property sector as their fiscal revenue generation is so highly dependent on land sales.”