The central government has tightened its grip over bond sales by local government financing vehicles (LGFV) as it strives to contain the risks of the sector.
The financing companies, set up by local governments to fund projects, would undergo extra scrutiny if their debt-asset ratio exceeded 65 per cent and the debt to be issued was rated below AA-plus, sources said, citing a notice from the National Development and Reform Commission earlier this month.
The nation's top economic planner approves LGFVs' bond sales. It decided to ban the sale of LGFV debt that was rated lower than AA-minus but would continue to allow the sale of bonds rated above AA-plus, the sources added.
The move is the latest attempt by the authorities to manage the risks of LGFV borrowings, after local government debt swelled to 16.5 trillion yuan (HK$20.8 trillion) at the end of last year.
That estimate, by UBS Securities, is equal to 32 per cent of gross domestic product.
"The NDRC's measures are aimed at better risk management of debt issuance of the financing vehicles as local governments are faced with mounting liabilities," said Fan Wei, an analyst at Beijing-based Hongyuan Securities. "I think it will make the bond market healthier."
LGFVs previously relied heavily on bank loans to finance infrastructure projects. At the end of last year, outstanding bank loans to LGFVs stood at 9.2 trillion yuan, or 13.8 per cent of the outstanding loans at mainland banks, according to the China Banking Regulatory Commission.
Bad loans at mainland banks rose for a sixth consecutive quarter in the January-March period, partly because of unprofitable projects. As banks have become increasingly reluctant to lend to them, LGFVs have turned to the bond market and the "shadow banking" industry for financing, especially since last year.
LGFV bond issuance surged 75 per cent last year compared with 2011, and trust loans grew 73 per cent, data showed.
The mainland's new leaders are highly attentive to financial risk. The Communist Party's Politburo Standing Committee, the nation's top decision-making body, said last month the country must guard against financial risks as growth moderated.
A State Council meeting on Monday also singled out the risk LGFV debt poses.
Yuan Gangmin, a researcher at the Chinese Academy of Social Sciences, said the new restraints on capital raising by LGFVs would prompt local governments to find novel ways to satisfy the demand for capital created by the building of projects, both useful and wasteful.
"They will come up with other innovative ways to raise funds," Yuan said, "ways that are hidden and harder to supervise."