Moody's: The upper tiers of China's regional and local governments exhibit high creditworthiness

Moody's Investors Service says that the upper tiers of China's regional and local governments (RLGs) display characteristics of high creditworthiness because of their close ties with the sovereign. Such characteristics suggest that the RLGs would exhibit ratings in a tight range and the weakest of this group would be at most only two notches lower than China's sovereign rating of Aa3.

Moody's also says that the RLGs are becoming significant bond issuers because of China's sweeping reform of public finance, including encouraging RLGs to borrow directly; thereby reducing the RLGs' traditional reliance on opaque borrowing through third parties.

Moody's analysis is contained in its just-released report titled "China's Regional and Local Governments:Upper Tiers Show High Level of Creditworthiness".

On the RLG bond market which is currently limited to upper-tier RLGs Moody's report says that the central government will pre-empt any RLG default to protect the nascent market.

The report points out that central government support is the dominant factor in Moody's assessment of the creditworthiness of upper-tier RLGs. The strength of such support outweighs the RLGs' idiosyncratic credit profiles.

Moody's report says that the central government will protect the RLG bond market by correcting the RLGs' liquidity problems before a default occurs; thereby accomplishing the central government's stated goal of not bailing out RLGs, while also eliminating contagion risk.

The central government's ability to avert an RLG default is enhanced by its power to directly intervene in RLG operations. For instance, it has the power to force RLGs to sell their state-owned enterprise assets in the event of debt payment difficulties. At end-2014, the RLGs held owners' equity in their SOEs totaling RMB17.1 trillion.

As for the detection of the RLGs' financial problems, Moody's report says that the probability of the central government's quick detection and resolution of such issues is enhanced by China's highly centralized system of government.

Moody's report points out that the central government sets all significant economic and financial policies affecting RLGs, and exhibits a high degree of financial oversight of RLGs. According to Moody's, such oversight indicates that the central government is willing and able to intervene in the financial affairs of upper-tier RLGs.

The RLGs are also financially dependent on the central government. For example, their combined funding shortfall was equivalent to 8.3% of the country's GDP in 2014. Such shortfalls are filled by central government transfers.

Moody's report also points out that since 2014, RLG officials have been held individually accountable for compliance with debt guidelines, and are subject to tough sanctions should breaches occur. The credible threat of severe punishment against RLG officials is one of the central government's tools for pre-empting defaults.