Be greedy when others are fearful.
Those who heeded Warren Buffett’s famous investment mantra would have benefited handsomely if they had jumped into Chinese municipal debt, which was identified as the region’s No. 1 financial risk this year in a Bloomberg survey. Instead, short-term bonds issued by China’s local government financing vehicles have rallied through the year.
The spread between one-year LGFV yuan bonds rated AA- with comparable central government notes fell to a record Wednesday, according to the latest available Bloomberg-compiled data. Yields have fallen for 20 straight days. Those on 5-year and 10-year securities have also seen their premium dropped.
Beijing’s support for the LGFV securities — via new loans and a debt swap program — has ripped up investors’ playbook for the $9 trillion market. Far from leading to a systemic blowup in the world’s second-largest economy, issuance is surging again as China seeks to jump-start stuttering growth and take financial pressure off its provinces and cities.
LGFVs are companies set up to borrow on behalf of provinces and cities, though the debt is frequently off balance sheets, in order to fund infrastructure and growth projects. While the goal is for them to become profitable, many struggle, leading to concerns by investors that their debt will need to be restructured.
Demand for other short-term yuan LGFV bonds has surged as well. Orders for a two-year notes issued by Yunnan Provincial Railway Investment have exceeded issuance by 71.15 times, according to a filing Monday. The spreads on the 5-year and 10-year debt have narrowed to the smallest this year.
Meanwhile, dollar notes issued by LGFVs have returned 6.57%, according to an iBoxx index, poised for their best year since 2019.
China’s financial regulators told its policy banks and biggest lenders to issue new loans to cover local governments’ debts that mature this year and in 2024. Beijing is also allowing provincial-level governments to raise about 1 trillion yuan ($140 billion) via bond sales to repay LGFV and other off-balance sheet issuers.
The People’s Bank of China Governor Pan Gongsheng said earlier this month that it will provide emergency liquidity support to regions with a relatively heavy debt burden when needed.
Still, the average maturity of LGFV bonds has declined by half a year as they increasingly sell debt maturing in 12 months or less, an indication that investors remain concerned about their long-term financial health.