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First LGFV default stirs China’s bond market

A quasi-municipal organisation in the Xinjiang Uighur Autonomous Region missed bond payment, making it the first bond default by LGFVs, raising concerns about the security of the bond once viewed as nearly risk-free.

A unit of the Xinjiang Production and Construction Corps (XPCC), a unique economic and paramilitary organisation with features similar to an LGFV to raise funds for the local government and carry out infrastructure investment, missed payment of interest and principal on a 500 million yuan ($72.6 million) note, according to the company’s statement to Shanghai Clearing House late Monday.

The company said on Tuesday that it also faces difficulty in raising funds to repay the 500 million yuan bond due on Aug. 19. The XPCC has about 2 billion yuan of bonds maturing before mid-March next year, among which 500 million yuan short-term notes will mature next week, according to Bloomberg-compiled data.

The bond default by the XPCC “unexpectedly breaks the last piece of belief that the Chinese government would bail out such funding platforms”, said Li Qilin, the chief macroeconomic researcher at the Lianxun Securities.

Despite a surge of bond defaults in China in the first half of this year, LGFVs managed to stay safe due to its deep connections with local governments.

“The missed payment occurs after the state council’s meeting pledged policy easing for infrastructure investing which has improved risk appetite in China’s bond market, making it a surprise,” said Sun Binbin, analyst with the TF Securities.

China last month introduced a package of fiscal policies aimed at invigorating the economy, while a State Council meeting also urged financial institutions to ensure reasonable borrowing demand from LGFVs. As a result, the spread between LGFV bonds and government bonds has been declining much faster than the spread between corporate bonds and governments, a sign of improved risk appetite for LGFV bonds and belief that there is implicit guarantee for payment by local governments.

“We are likely to see some sell-off in LGFV bonds after the incident,” said Li Qilin. “The market will also probably reprice LGFV notes to factor in more default risks,” Li added.

“The incident is likely to be turing point after which that quasi-municipal bonds and corporate bonds will eventually be put into a same basket and investors are expected to reprice LGFV bond for more risks,” said Li.

“As the scrutiny over local government debt has not been relaxed and continues to impose pressure on local government fiscal conditions, the bond default by XPCC is likely to exert pressure on financing channel via quasi-municipal bond offering, ” said Li.

“LGVFs in Xinjiang region may be affected badly by the latest default,” Huang Weiping, chief fixed income analyst Industrial Securities Co., wrote in a report on Tuesday. “Many LGFVs in Xinjiang are very weak financially and lack of investor confidence may result in a sharp fall in demand for their notes.”

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