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China LRGs In Focus: Yunnan (Province Of)

This is part of a series of reports on Chinese local and regional governments (LRGs). Using publicly available information, S&P Global Ratings will provide analytical opinion based on key credit metrics, allowing readers to assess the creditworthiness of each LRG relative to its domestic peers. These LRGs form the backbone of the mainland economy and, together with their state-owned enterprises and local government financing vehicles, are among China's highest volume debt issuers.

Summary

Strengths
  • Strong systemic support from the central government through the institutional arrangements for provincial governments.
  • Capability of the provincial government to maintain satisfactory fiscal performance through decisions on sharing of revenue and spending with lower-tier governments.
Weaknesses
  • Underdeveloped local economy by domestic and international comparison.
  • High debt burden largely due to debt on-lent to lower-tier governments.
  • Lax oversight over weak-performing state-owned enterprises (SOEs) poses contingent liabilities for the provincial government.

Table 1

Comparative Snapshot Of Key Credit Metrics
China Yunnan
2015-2019 average 2019 2015-2019 average 2019
GDP (bil. RMB) 83,549 99,087 1,718 2,322
GDP per capita (RMB) 60,258 70,892 37,060 47,944
GDP per capita (x of the national average) - - 0.6 0.7
GDP growth (YoY %) 6.7% 6.1% 8.8% 8.1%
Adjusted operating revenue (bil. RMB)* 9,748 11,270 373 468
Operating balance as % of adjusted operating revenues§ 7.3% 4.7% 4.1% 1.4%
BACA as % of adjusted total revenues† -3.6% -5.3% -5.1% -5.8%
Direct debt (bil. RMB)‡ 17,278 21,307 688 797
Direct debt excluding onlending (% of whole province) 14.1% 14.9% 23.4% 26.0%
Off-budget debt (bil. RMB)**1 7,009 8,259 542 682
Tax-supported debt burden (% of consolidated operating revenues)§§1 206.0% 208.8% 205.0% 190.7%
Tax-supported debt excluding onlending (% of consolidated operating revenues)††1 82.0% 85.8% 116.0% 119.0%
China columns represent the LRG Tier-one sector, except for GDP, GDP per capita, and real GDP growth. Yunnan columns represent the Yunnan provincial government, except for GDP, GDP per capita, and real GDP growth. *Adjusted operating revenue: Own operating revenue plus transfers inflow under general government account. §Operating balance: Adjusted operating revenue minus adjusted operating expenditure; Adjusted operating expenditure: Own operating expenditure, adjusted down by capital items, plus transfers outflow under general government account. †BACA--Balance after capital account: Operating balance plus capital account balance; Capital account balance: Adjusted capital revenue minus adjusted capital expenditure; Adjusted capital expenditure: Own capital expenditure, adjusted up by capital items, plus transfers outflow under government fund account. ‡Direct debt: Outstanding debt explicitly under LRG legal name. **Off-budget debt: Debt of local government-owned enterprises with outstanding onshore bond, whose debt repayment S&P Global Ratings deems as supported by LRG fiscal revenue. §§Tax-supported debt: LRG direct debt and off-budget debt. ††Tax-supported debt excluding on-lending: LRG direct debt excluding onlending and off-budget debt; Consolidated operating revenues: LRG's adjusted operating revenues, plus operating revenue generated by referenced local government-owned enterprises; 1: Numbers are for 2015-2018 average and 2018. LRG--Local and regional governments. RMB--Chinese renminbi. Source: Various government websites, Wind, S&P Global Ratings.

Background

Yunnan is the frontier of the southwestern part of China. It borders Vietnam, Laos, and Myanmar. Domestically, Yunnan neighbors Guangxi, Guizhou, Sichuan, and Tibet. The province accounts for roughly 4% of China's land area, 3% of population, and 2% of GDP. The provincial government administers 16 city governments and autonomous prefectures that we classify as tier-stwo local governments. These include the provincial capital of Kunming. There are 129 tier-three local governments within the province, as of end 2018.

A significant part of this report, and the series, will analyze the distinction between "province level" and "whole province" data. We apply our analysis on an individual basis, which means we largely focus on province-level government financial statements, with the whole-province data serving as a supplement to capture risks associated with lower tiers of governments. In its simplest sense, province-level data are the primary figures we analyze. We supplement this view using whole-province data, which encompass the cities, districts, and other lower-tier governments within Yunnan province.

Much of the challenge in analyzing Chinese local government debt lies in determining how much SOE debt may become the financial obligation of the government. This report provides estimates of such obligations and the implications for Yunnan at the province level.

All metrics included in this report are calculated based on publicly available data and according to S&P Global Ratings definitions. This report does not constitute a rating action.

Institutional Framework

  • The Yunnan provincial government is in the top tier of LRGs.
  • Revenues at this level amply cover expenditures, aided by the central government's strong systemic support.
  • Top-tier China LRGs still trail the disclosure standards of international peers.

The Yunnan provincial government is at the top of China's four tiers of LRGs. S&P Global Ratings assigns an institutional framework score to each of the top three tiers of LRGs in China. The institutional framework defines the environment in which an LRG operates and measures how the predictability, reliability, and supportiveness of public finance systems and legislative frameworks may affect an LRG's ability to service debt in the long term. Tier-one governments include provinces, autonomous regions, municipalities, and cities with state-planning status.

We view tier-one governments as having an "evolving, but balanced" institutional framework. Their credit profiles are supported by revenues that we consider as adequate to cover expenditures. These governments also benefit from strong support from the central government on an ongoing as well as an extraordinary basis. Although financial reforms are still evolving in China, we consider the fiscal outcomes for tier-one governments as generally predictable.

We view the level of disclosures and audit controls among Chinese tier-one governments, especially regarding their off-budget activities and management of SOEs, as a risk. We believe these governments' disclosure and information quality is less timely and detailed than that of peers in developed economies.

Economy

  • Yunnan is one of China's poorest economies due to geological disadvantages.
  • It is one of the fastest growing economies, driven by investments.
  • Development within the province is uneven.

Yunnan has a very weak economic base, with GDP per capita 32% lower than the national average. The province's underdeveloped state is partly due to its vast mountainous terrains and the inland location. Yunnan's economic pillars, namely tobacco, hydropower, metals and mining, tourism, and bio-industries, benefit from the province's unique natural endowments. However, it is difficult for these industries to achieve economies of scale in such terrains without well-built infrastructure.

Farming remains a primary source of living for more than half of Yunnan's residents. The urbanization rate is 48.91% as of end 2019. In addition, the province borders some less economically developed countries and does not have advantages in exports, especially in labor-intensive activity.

Yunnan has been playing catch-up in terms of economic growth over the past 10 years post the global financial crisis, and we expect the momentum to sustain. We attribute the province's high growth to investments (both private and public), partly induced by liquidity provisions under the central government's guidance. We believe China's much-reiterated "Going West" strategy will continue to support industrial and infrastructure development in the province.

Economy development is unbalanced within Yunnan. Although the province has eight cities and eight autonomous prefectures, the capital city of Kunming alone accounts for close to 30% of the province's GDP.

Chart 1

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Budgetary Performance

  • With weak tax generation due to an underdeveloped local economy, Yunnan is highly reliant on transfers from the central government.
  • We expect the provincial government to maintain moderate fiscal deficits. This is given its ability to decide sharing of revenue transfers with lower-tier governments and responsibility for much of the capital spending at lower-tier governments.

We assess Yunnan provincial government's budgetary performance as average when compared with domestic and international peers. We expect the government to maintain a modest operating surplus and an overall deficit of 5%-10% of adjusted total revenues in the next two years.

Over 2015-2019, the Yunnan provincial government had an estimated average operating balance of 4.1% of adjusted operating revenues and balance after capital account of -5.1% of adjusted total revenues. The whole province's fiscal deficit, however, was much larger. It had an estimated average balance after capital account of -12% of adjusted total revenue. This highlights the province's increasing spending needs vis-à-vis revenue challenges from a still underdeveloped economy. Yunnan relies heavily on central government transfers, which made up close to 60% of adjusted total revenues in 2019.

We expect the Yunnan provincial government to maintain a modest fiscal deficit and continue to fare better fiscally than the whole province, thanks to its fiscal authority over its lower-tier governments. The provincial government allocates central government transfers between itself and the lower-tier governments. In 2015, it passed 98% of these transfers to lower-tier governments. In 2018, this ratio dropped to 90%. Moreover, much of the capital spending is at lower-tier governments, contributing to a much larger deficit at that level.

Chart 2

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Chart 3

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Chart 4

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Debt Burden

  • The provincial government's debt burden is likely to remain high over the next two years.
  • We view the provincial government as being fully liable for LRG bonds issued in its legal name, although 75% of the direct debt is onlent to lower-tier governments.
  • There is a risk of the SOE borrowings materializing as the government's own burden.

The government's tax-supported debt (direct debt + off-budget debt through SOEs) has stabilized at about 190% of consolidated operating revenues in 2018-2019. This ratio appears high by international standards. However, it is below the China sector average of 209%. This ratio takes into account the direct debt of the government as well as debt of its provincial SOEs that carry important policy activities while remaining financially or operationally dependent on the provincial government.

The tax-supported debt burden has been trending down in the past few years, thanks to growing revenues. We expect the indebtedness to stay at around current levels as the central government allocates increasing amounts of debt quota to spur public investments.

We view the Yunnan provincial government as being fully liable for LRG bonds issued in its legal name, primarily because the lower-tier governments generally have weaker fiscal positions. The provincial government onlends 75% of its direct debt to lower-tier governments.

We identified about Chinese renminbi (RMB) 682 billion as off-budget debt undertaken by SOEs as of end-2018, largely to invest in local infrastructure projects on behalf of the government. We include this amount in our assessment of the provincial government's tax-supported debt burden. We consider the remaining provincial SOE debt of RMB160 billion as contingent liabilities of the government. The contingency reflects the reality that, if these SOEs enter financial distress, the government owner's creditworthiness may take a hit through lower economic activity, greater fiscal spending, or greater debt burden to support the SOEs.

In our view, such contingent risks are substantial for the Yunnan government. This is because the provincial government's SOE sector is generally highly leveraged, and there is a track record of SOEs being in credit stress and the provincial government utilizing controllable resources to rescue them. In addition, Yunnan's commercial SOEs are relatively concentrated in commodity-related sectors. As such, there is an elevated risk that they will run into stress if the commodity price cycle turns.

Chart 5

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Chart 6

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Chart 7

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Other Credit Factors

  • Yunnan's financial management is under China's highly centralized political system but its management of SOEs is weak.
  • Liquidity is supported by access to a liquid capital market.

S&P Global Ratings assesses the creditworthiness of non-U.S. LRGs by combining its assessment of their institutional framework and individual credit profiles to arrive at the anchor, a core element for assigning an issuer credit rating.

In addition to institutional framework analysis, we cover economy, budgetary performance, and debt burden as three of the five credit factors to assess individual credit profiles of LRGs. Analysis of the other two factors--financial management and liquidity--remains subject to more information. We generally view these factors as being supportive to the creditworthiness of most tier-one LRGs.

While financial management of most tier-one LRGs is satisfactory, in our view, Yunnan's management is considered weaker than its peers'. This is largely driven by its lax SOE management as evident by episodes of SOE distress. Specifically, we assess that the government has been ineffective in measures to manage the weaker stand-alone credit profiles of its SOEs, in part leading to the credit episodes in Yunnan Metropolitan Construction Investment Group, Yunnan Real Estate Development & Operation Group, Yunnan State Owned Assets Management Company, Yunnan Coal Chemical, and Yunnan Transportation Investment & Construction Group (previously Yunnan Road Development & Investment Company).

Other aspects of Yunnan's financial management are more in line with other tier-one LRGs. The central government appoints experienced and senior leadership positions in LRGs. It sets out general guidance of short-term and long-term financial planning, leading to LRGs' strong track records of consistently meeting their budget plans. Still, most LRGs continue to engage in off-budget borrowing activities through SOEs, largely due to their limited funding alternatives. These SOEs weigh on the tier-one government's debt position in stressful scenarios.

The liquidity profile of most tier-one LRGs is a supportive factor, in our view. Most of them have high cash and liquid asset holdings. In addition, most tier-one LRGs benefit from strong access to capital markets and have issued municipal bonds directly. We also expect the central government to provide liquidity support to these LRGs when needed.

Related Research

  • China Provincial Governments' Risk Indicators, June 10, 2020
  • Not All Of China's Tier-One Local Governments Are Equal, March 19, 2020
  • Public Finance System Overview: Chinese Provincial Governments, Feb. 12, 2020

This report does not constitute a rating action.

Primary Credit Analyst:Wenyin Huang, Hong Kong + 852 2532 8007;
Wenyin.Huang@spglobal.com
Secondary Contact:Alex Lam, Hong Kong +852 2533 3552;
alex.lam@spglobal.com

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