By any account, last month was not a good time to sell a Chinese bond backed by its railways.
A local cash crunch had already limited the pool of available buyers, while concerns about the country’s local government debt problems persist. And that was before Saturday’s fatal train crash in Zhejiang province, which killed at least 40 people and is now being censored by the government.
So no surprise, perhaps, that last week China’s Ministry of Railways (MoR) found buyers for only Rmb18.7bn of the Rmb20bn of medium-term bonds it had planned to sell.
By all accounts, it’s the first time that’s happened for the MoR.
And so, Standard Chartered analyst Stephen Green has decided to take a post-mortem look at the bonds’ prospectus. Perhaps unsurprisingly, he’s found plenty of unsavoury, non-transparent things.
For a start, he says, the MoR has about Rmb1,980bn ($300bn) worth of debt already, with only Rmb560bn of that accounted for by publicly-issued bonds. Most of the rest appears to be … bank loans.
And that’s where things get interesting:
In 2010, the MoR repaid the banks CNY 125bn in principal and also paid CNY 25bn in interest. This interest paid implies an overall interest rate of some 2% on its shortand long-term debt, as Chart 2 shows. We find this hard to understand given that the majority of the ministry’s debt is bank loans with a minimum rate of 4.5-6% (depending on whether they are policy loans and when the loans were issued.) We wondered about interest costs being capitalised, but we could not see any notes explaining such a procedure in the accounts. It is also possible that interest is not being paid and is instead being added to the outstanding loans. In 2010, the MoR borrowed an additional CNY 685bn, which increased its net borrowing by CNY 560bn.
Which leads nicely into the topic of debt sustainability.
We know already that profits at the MoR are really small — like Rmb$15m small — or a return on assets (ROA) of just 0.0005 per cent, according to Green. In order to answer the question of whether the MoR is throwing up enough cash to cover its debt, however, you need to dig a little deeper.
Before tax is paid, most of the MoR’s operating profits are transferred to the Railway Construction Fund (RCF), another central government fund overseen by China’s Ministry of Finance (MoF). The MoF then authorises payments back to the MoR which are roughly equivalent to the original MoR transfers into the fund. Transfers are not taxed so this is basically a way for the MoR to avoid paying corporate tax on its operating profits. If you add the RCF payments back to the ROA calculator then you get an operating profit of Rmb67bn for last year, or an ROA of 2 per cent. You can boost that to 4 per cent if you do stuff like include completed fixed assets, but you get the idea — the MoR still has a relatively palty ROA.
And, Green says, there’s something missing:
What is sorely missing from the MoR’s accounts, at least as far as we can see, is clear evidence of budgetary transfers from the MoF – though they could be hiding in the CNY 240bn that appears as ‘other’ sources of funds. For its part, the MoF’s budget shows CNY 155bn of spending on rail and carriages in 2010, but just CNY 16bn of spending in 2011. These are small amounts. The MoR’s total debt increased CNY 92bn in Q1-2011 alone.
In sum, just as with the local government investment vehicles (LGIVs), public rail infrastructure is being run mostly through the banks’ balance sheets as well as through the public debt markets, rather than through the budget … Just as with the LGIVs, the advantage of this is a superficially healthy official budget each year, ever-larger banking sector exposure to non-free cash generating assets, and a hidden tax on hard-working households’ bank deposits.
For Mandarin speakers, there’s a full copy of the MoR prospectus in the usual place.
Related links:
Rail bonds head for longest losing streak since 2008 – Bloomberg
Waiting for a Chinese local debt disaster – FT Alphaville
China’s uncollateralised, cash flow-less, local government loans - FT Alphaville