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But defaults by local government financing vehicles could create ‘short-term instability’ at local level
PHNOM PENH - Moody’s Investors Service says it continues to view the risk of a systemic financial crisis in China as low.
“The uniquely integrated nature of China's institutional framework, economy and financial system acts both as a powerful instrument of credit risk mitigation and a potential conduit for the transmission of financial shocks,” the US rating agency said.
In a report released in Singapore on Tuesday, Moody's noted the emergence of local government financing vehicles as an asset class for investors.
Regional and local governments
The report also highlighted the exposure and resilience of regional and local governments to “problems surfacing”
in state-owned enterprises or local banks.
Regional and local governments "play a major role in directing and executing public investment, which has been a key driver of China's economic expansion in the past,” it said. They are "again growing in importance as the authorities seek to counteract slowing growth.”
Local government financing vehicles
Moreover, they continue to rely on local government financing vehicles to fund a “significant portion” of their infrastructure investment.
As a result, these vehicles have emerged as “major issuers of bonds in China's onshore and offshore markets, presenting both an opportunity and important source of credit risk in investor exposure to China.”
Moody’s said China's central government relied on regional and local governments to stimulate the economy.
But it has sought to limit their ability to support the financing vehicles with aim of increasing budget discipline. The central government also aims to limit growth in public sector leverage and enhance the financial transparency of regional and local governments.
‘Potential for defaults rising’
As a result, credit differentiation among the financial vehicles is increasing, "with the potential for defaults rising in particular at the weaker end of the spectrum."
“Moody's continues to view the risk of a systemic financial crisis in China as low,” the report said.
But rising defaults by the financing vehicles “could create short-term instability at the local level.”
The report said China's initial response to any financial stress “usually involves a degree of burden sharing between public and financial institutions.”
This could add to strains on regional and local governments — and small local banks which have less access to capital and liquidity than larger financial institutions.
Increasing pressure on small local banks
The small banks are likely to face “increasing pressure” as more local state-owned enterprises — including the financing vehicles — experience financial strains.
Moody’s said China’s central government was “unlikely to provide direct financial support” for state enterprises owned by regional and local governments.
But “it can direct, mobilize, and permit necessary resources to prevent a (state-owned enterprise) from defaulting,” the rating agency said.