(Yicai) Nov. 13 -- Institutional investors are rushing to buy high-quality urban investment bonds after China set out a plan to deal with the hidden debts of local authorities, prompting a drop in yields. But they remain cautious about UIBs from smaller cities due to lingering concerns over debt quality and investment sentiment.

To replace the existing local government hidden debt, the central government lifted the debt ceiling by CNY6 trillion (USD834.8 billion) on Nov. 8. The finance ministry said CNY800 billion (USD110 billion) will be allocated from newly added local government special bonds annually for five years specifically for debt resolution, with half of that amount used to swap out hidden debts.

CNY2 trillion (USD278.3 billion) of hidden debts for shantytown renovation due in 2029 and subsequent years will still be repaid under the original contracts, Finance Minister Lan Fo'an said.

Since then there has been a a surge in demand for UIBs, debt instruments issued by local government financing vehicles to fund infrastructure projects, with institutional investors holding these notes reluctant to sell, according to a bond fund manager at a foreign mutual fund company.

The yield on the 10-year treasury bond tumbled 3 basis points to 2.11 percent on Nov. 8 amid that week’s major events, including the announcement of the debt resolution plan, the US presidential election, and a rate-setting meeting of the US Federal Reserve, said Wang Qiangsong, head of research at South China Bank Wealth Management.

Looking ahead, the key issue for the bond market will be the strength and pace of economic recovery, Wang pointed out. Given China’s relatively loose monetary policy and limited fiscal stimulus, the bond market is expected to remain volatile through the end of the year, he added.

Most financial institutions expect monetary conditions to loosen further, and they advise taking advantage of the year-end window to hike allocations in one- to three-year bonds.

Despite the rush into UIBs, institutional investors remain very cautious about bonds issued by smaller cities and counties, according to a bond investment manager at an insurance asset management firm.

Apart from the varying quality of UIBs, the surge of funds into the stock market ahead of the National Day holiday, when the Shanghai Composite Index briefly topped 3,600, led to significant outflows from the bond market, thereby worsening investor sentiment, the person said.

The debt resolution plan mainly involves debt replacement, not debt reduction, meaning the responsibility for resolving the liabilities still lies with local governments, said Wang Lei, director of corporate ratings at S&P Global (China) Ratings.

So the higher debt ceiling may favor more economically developed regions, he said, with some eastern provinces in particular likely to resolve their hidden debts ahead of schedule, enabling them to focus more on economic growth.

Editor: Kim Taylor