Beijing’s readiness to help local governments avoid default has created a ticking time bomb, say analysts

China has embraced the idea of defaults imposing some discipline on debtors in its bond market. And some of the most troubled debtors are local governments’ financing vehicles (LGFV). So an LGFV default has long seemed on the cards. But it just isn’t happening.

Moody’s Investors Service thought the first one might come in 2017. Almost two years later, there have been some close calls – including with a late payment by a unit owned by Qinghai province on a dollar bond last month that caused ripples through the investment community – but no default.

What it suggests is China’s leadership is not prepared for a borrower with a regional authority’s imprimatur to renege on its principal, triggering higher borrowing costs across a swathe of the world’s third-largest bond market. Stepping in with official assistance when needed will help local authorities sustain the development spending key to holding up national growth. The cost may be an even bigger future reckoning with bad debt.

“In the longer run, someone has to pay eventually for this so-called ‘kick the can down the road’ plan – taxpayers and depositors perhaps,” said Desmond How, head of fixed income, GaoTeng Global Asset Management. Regulators may need to reverse some policies, giving LGFVs greater rein to borrow to help support economic growth, How said.

Finance Minister Liu Kun said over the weekend that accelerated debt sales will help to boost domestic demand, underlining the importance of bonds as a stimulus tool.

For investors willing to stomach the occasional late payment, the implicit backing for LGFVs offers some yield pick-up. Luo Xianzhi, fund manager at Shanghai Tianzeng Investment Management, says he is sitting on a 9 per cent annualised return since he started stocking up on local securities last November.