Defaults among lower tier government-backed bond issuers in China could rise as US$560 billion matures in next two years

China’s debt market is at a crucial juncture. With 3.8 trillion yuan (US$560 billion) of bonds issued by government affiliates maturing in the next two years, defaults among lower tier issuers could rise, according to S&P Ratings.

But the chances of default vary widely among China’s state-owned enterprises (SOEs) and local government financial vehicles (LGFVs) as a debilitating trade war with the US slowed China’s economy to a record low of 6.2 per cent in the second quarter.

“Large state-owned enterprises (SOEs) with a large impact on the market are likely to see increased support from the government, but the smaller, lesser known, less impactful SOEs, particularly those engaged in sectors hit by the trade war, might see defaults rise,” Charles Chang, an independent analyst covering the China credit market, said during S&P Ratings annual credit roadshow in Hong Kong, on Wednesday.

Gloria Lu, an infrastructure analyst at S&P, said local governments remain committed to supporting SOEs and LGFVs’ fundraising plans to finance infrastructure development. But the fundraising capacity varies between governments at different levels.

“For example, a provincial government with stronger sources of income will have much more resources that could be moved around to support an LGFV, compared to a city-level or county-level government,” she said.

The ratings of LGFVs vary, depending on their risk profile. Investors used to have implicit faith in government-backed bonds issued by SOEs and LGFVs. However, recent incidents, including late payment of interest and skipping of call options has left investors wondering if the chances of default are rising if the governments backing these issuers are unable to bail them out once they are in trouble.