In a rare dispute between provinces over the sale of local government bonds, the finance department of Henan province in central China blacklisted a brokerage firm controlled by the municipality of Tianjin this week after the firm failed to pay in full for the bonds it had bought.

The incident is the latest in a series that underscore the rapidly worsening financial situation in Tianjin, one of the four mainland cities that are under direct supervision of the central government.

According to Henan's finance department, Tianjin-based Bohai Securities, in which the municipal government owns a 25 per cent stake, bought 375 million yuan (US$55 million) of special purpose bonds via auction on September 9.

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But Bohai Securities only paid 30 million yuan the day after the auction, less than 10 per cent of the value of the bonds. The default, the first-of-its-kind nationwide, led the Henan government to remove the firm from its list of authorised bond underwriters until 2022.

In a response to the official China Securities Journal newspaper, Bohai Securities blamed the default on an employee from its bond underwriting department who was not aware of the result of the auction until two days later, causing it to miss the payment. It added that the firm tried to pay again later but did not succeed.

The proceeds from special purpose bonds are mainly used to fund infrastructure and housing projects.

The rare default of a state-controlled financial institution on a local government bond purchase is the latest case exposing financial troubles in the port city of Tianjin, one of the most indebted governments in China.

Over the past few years, the municipality of 15.6 million residents has attempted to restructure its economy, but slowing growth has undermined its debt-fuelled investment model.

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Since 2016, Tianjin's growth has dropped sharply partly because it was forced to reduce the gross domestic product figure for that year initially generated by Binhai New Area, the biggest economic contributor to the city, by a third after a controversy over data forgery emerged.

It has also been attempting to restructure its economy to move away from traditional heavy industries and curb pollution.

In 2019, the city's economy grew by 4.8 per cent, below the national average of 6.1 per cent. In the first half of 2020, its economy contracted by 3.9 per cent, which was one of the worst performances among China's 31 provincial-level jurisdictions.

Weaker growth, coupled with tax and fee cuts mandated by Beijing to stimulate growth, eroded the city's revenues. In the first six months of the year, Tianjin's revenue dropped by 17 per cent from a year earlier, a sharper fall than its expenditure, which declined by 15 per cent, according to government data.

In addition, the city's revenues from land sales plunged to 45 billion yuan (US$6.6 billion) in the first half of 2020, which was around half the level compared to the same period last year, as property developers became reluctant to invest money in the city.

"The Tianjin municipal government's budgetary performance is among the weaker of tier one governments in China. It has deteriorated rapidly to one of the widest overall deficits among domestic peers in the past three years," rating firm S&P Global said in a research report.

"We expect the municipal government to continue dealing with deficits at elevated levels over the medium term, because we view the pressures on its fiscal capacity as rather structural than temporary."

According to S&P Global, from 2015 to 2019, Tianjin had an average budget deficit equal to 9 per cent of its total revenue, which was much higher than 3 per cent among all provinces between 2015 and 2018.

Last year, the city's overall debt - including that from local government financing vehicles (LGFV) that are state-owned firms that borrow to fund infrastructure and other public projects - was 2.4 times larger than the revenues it generated from tax, fees, land sales and other sources, according to Liu Yu, a fixed income analyst at GF Securities.

Other analysts have estimated that the city's debt burden is much higher. At the end of June, Tianjin's total LGFV debt represented around 9.5 times of its annual fiscal revenues, while interest payments on LGFV debt alone represented an estimated 37 per cent of total bank lending within Tianjin, according to an analysis by Logan Wright from New York-based consultancy Rhodium Group.

Shrinking revenues and the high debt load have hamstrung the municipal government's ability to support many of the firms that it owns. The government said the state-owned enterprises under its management had a total liability of 3.8 trillion yuan (US$559 billion) at the end of March last year. Technically, the government is responsible for much, if not all, of that debt.

In late August, Tianjin Real Estate Trust Group, a property developer under the government's de facto ownership, defaulted on a bond traded on the Shanghai Stock Exchange after failing to pay interest of 15.8 million yuan (US$2.3 million) and principal of 200 million yuan (US$29.4 million) due to bondholders.

The firm said the default was due to a cash shortage and limited availability of new financing after Beijing tightened regulations on developers' balance sheets to curb rising housing prices. The default led Chinese rating agency Pengyuan to downgrade the developer's long-term credit profile from AA- to C. It also flagged a default risk on the firm's 3.6 billion yuan bond repayments that are due in the coming year.

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Tianjin Real Estate Group, the developer's parent company that is wholly owned by the municipal government, was supposed to help repay the debt if a default occurred, but the group itself is burdened by high debt and risk of default. It has not disclosed any audit reports for the past two years, leaving the public with only scanty knowledge of its financial position.

At the same time, the group's market-based, mixed ownership reform stalled over the past three years after several private firms pulled out of negotiations following a series of corruption scandals among its top leadership. In a desperate effort to boost cash flow, the group sold a land parcel this month at half the price that it bought it for three years ago.

In December, Tewoo Group, a state-owned commodity firm from Tianjin, defaulted on an offshore bond worth US$1.25 billion, one of the largest state-owned enterprise defaults in the offshore market, after the government was unable to lend support. Tewoo is now under bankruptcy restructuring.

This article originally appeared in the South China Morning Post (SCMP), the most authoritative voice reporting on China and Asia for more than a century. For more SCMP stories, please explore the SCMP app or visit the SCMP's Facebook and Twitter pages. Copyright © 2020 South China Morning Post Publishers Ltd. All rights reserved.

Copyright (c) 2020. South China Morning Post Publishers Ltd. All rights reserved.