August 7, 2015 / 9:38 AM / 4 years ago

China's muni bond market shows signs of stress after auction undersubscribed

By Pete Sweeney
    SHANGHAI, Aug 7 (Reuters) - China's fledgling municipal bond
market is showing increasing signs of stress after a provincial
bond market auction went undersubscribed for the first time in
four years.
    One auction of 10-year bonds by the northeastern province of
Liaoning failed to sell out on Friday and yields on other
auctions by the province rose by between 20 and 29 basis points
from an auction by the Xinjiang ethnic autonomous region on
    Beijing revamped its bond market in 2014, allowing local
governments to issue such bonds directly. It followed up by
launching a massive local debt swap that exchanged high-yielding
local government financing vehicle (LGFV) debt for the new
municipal bonds.
    Average muni bond yields have been rising since May. The
average yield for seven-year municipal bonds, which in May were
trading only 20 basis points above the sovereign rate, had by
end-July opened up a 50 basis point gap above treasuries and
were trading in line with policy bank debt.
    Analysts have flagged China's recent move to further open
the domestic bond market to international capital as a response
in part to lukewarm demand, especially from non-bank clients,
for new municipal debt, whose issuance could reach more than 2
trillion yuan ($322 billion) this year.
    "The scale of the debt swap is such that demand from onshore
investors may not be sufficient to meet the substantial increase
in government bond supply," said Saifeng Mao, an associate
director at Fitch Ratings in Hong Kong.
   However, the stress has not translated into the broader money
market, where rates remained relatively stable and
accommodative, with the benchmark seven-day repo money rate
losing a few basis points to 2.42 percent.
    That marks a return to the multi-year lows of May, when the
repo rate dipped below 2 percent for a time thanks to aggressive
monetary easing by the central bank.
    China's foreign exchange reserves, the world's largest, fell
by $42.5 billion in July to $3.65 trillion, central bank data
showed on Friday, the sharpest monthly drop since March amid
signs of capital outflows. 
 Instrument     RIC              Rate*    Change
 1-day repo                         1.53           7.29
 7-day repo                         2.42          -1.49
 14-day repo                        2.54         -12.45
 7-day SHIBOR                       2.45           -5.6
*The volume-weighted average price (Vwap) at midday Friday
** Compared to the Vwap at market close the previous Friday
 Contract       RIC       Rate*     Pct
 Sep 2015                    97.04    -0.01
 Dec 2015                    98.89     0.04
 Mar 2015                    99.30     0.00

($1 = 6.2086 Chinese yuan renminbi)

($1 = 6.2087 Chinese yuan renminbi)

 (Additional reporting by Nathaniel Taplin; Editing by Alan
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