Aug 25, 2014 05:26 PM

Beijing City Gov't Bonds Have Yields Higher than Those from Finance Ministry

(Beijing) – The Beijing city government has required the underwriters of its bonds to ensure yields higher than those of bonds with comparable durations issued by the Ministry of Finance, a source with one of the underwriters says. This is a sign it is committed to seeing the interest rates of its bonds accurately reflect risk, something the central government has said it wants.

The city government's 10.5 billion yuan worth of bonds with maturities of five, seven and 10 years were sold at the yields of 4, 4.18, and 4.24 percent on August 21. All those yields were slightly higher than the average for central government bonds of the same maturity over the previous five days.

Bonds issued by local governments generally pay investors more because the risk is greater than for central government debt, which is backed by sovereign credit. In China, however, the pricing of local and central government bonds usually do not reflect the risk involved.

In July, the eastern province of Shandong issued 13.7 billion yuan worth of bonds with three maturities, all at a yield about 20 basis points lower than those of comparable central government bonds. It is the widest gap in yields ever seen since the country started a pilot program this year that allows 10 provincial and municipal governments to issue bonds on their own instead of through the ministry.

The Beijing city government later announced the rules for its bond issuance, setting a range for the yields to be 0 to 15 percent above those of central government bonds. All seven local governments that had completed their bond sales set the range as 15 percent on either side.

The underwriter source said officials from the Beijing government told them to make sure the yields are higher than central government bonds.

A source close to the ministry said the Beijing government did not push up its bond yield because the ministry told it to. "It depended only on the local government's political awareness," he said.

The phrase "political awareness" was a reference to the central government's goal of establishing a market-oriented bond issuance mechanism for local governments to hold them responsible for their spending and have more transparent budgets.

The country's Budget Law prohibits local governments from issuing bonds, so the ministry issues them on their behalf. The problem with the arrangement is that all of the bonds are priced similarly and close to central government bonds.

The pilot program launched this year was meant to change that, but analysts say the yields of the eight local governments still do not reflect their risk. Shanghai and Shenzhen have not issued bonds yet.

Banks are willing to buy local government bonds because they see the purchase as an opportunity to form good relations with the government, which would pay off in other ways, a banker close to the underwriting of Shandong's debt said.

The eight local governments have sold 92.4 billion yuan worth of bonds, accounting for 84.6 percent of all pilot local government bonds scheduled for sale this year.

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