UPDATE 1-China investors flock to Jiangsu bonds despite debt fears
* Jiangsu yields nearly as low as central government bonds
* Jiangsu is China's most indebted province - analysis
* Province has borrowed heavily from shadow banking sector
* But municipal bonds viewed as safer than shadow debt
SHANGHAI, Oct 10 (Reuters) - China's Jiangsu province sold 15.3 billion yuan ($2.50 billion) worth of bonds at low yields on Thursday, suggesting that investors see little risk of default by one of the country's richest provinces but also its most heavily indebted.
Chinese localities are forbidden from issuing debt directly outside the small pilot project under which the province sold debt on Thursday.
But since 2009, local governments such as Jiangsu have increasingly evaded this restriction by borrowing through state-owned investment companies known as local-government financing vehicles (LGFVs). Such borrowing is technically corporate debt but is widely understood to carry an implicit government guarantee.
The pilot project for direct bond issuance is an effort to make local government debt issuance more transparent by decreasing reliance on opaque financing vehicles.
The yields of 3.88 percent and 4.00 percent, respectively, for five- and seven-year bonds auctioned on Thursday were both within three basis points of yields on central government bonds of the same maturity .
The low yields suggest that investors view Jiangsu's directly-issued bonds, which carry an explicit government guarantee, as much safer than debt issued by its LGFVs. Many trust loans carry interest rates above 10 percent for one- or two-year loans.
In August, local media cited unnamed Jiangsu authorities saying that LGFVs in Jiangsu have outstanding bank loans of 770.6 billion yuan and have raised an additional 576.8 billion yuan through non-bank financing channels such as wealth management and trust products.
Financing vehicles in Jiangsu accounted for 30 percent of all investment trusts sold in China in 2012, Shenzhen-based data provider Use-Trust said.
The risk that Jiangsu might pose to the Chinese economy in a crisis is clear. On its own, the province would be a top 20 global economy with GDP greater than G20 member Turkey. Its 79 million population tops that of most European countries.
Late last month, provincial authorities announced new measures to control new debt issuance by cities and towns.
The Jiangsu bond auction marks the fourth time this year that a Chinese local government has issued bonds directly, without the central government finance ministry acting as a proxy.
The finance ministry said in March that it would raise the quota for direct issuance of local government debt to 350 billion yuan for 2013, up from 250 billion yuan in 2012, under this pilot, which was launched in 2011. This quota includes both independent local auctions and auctions in which the finance ministry sells bonds on behalf of localities.
Including Thursday's auction by Jiangsu, local governments have sold 290.8 billion yuan in bonds so far in 2013, of which 49.8 billion were sold directly by localities, with the remainder sold via the finance ministry.
In July, the finance ministry announced that it was adding Shandong and Jiangsu provinces to the group of local governments permitted to issue bonds independently, bringing the total number of localities to six.
($1 = 6.1211 Chinese yuan) (Reporting by Gabriel Wildau and Steven Bian; Editing by Jacqueline Wong)
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