SHANGHAI China's struggling Liaoning province, a bellwether for China's municipal debt, sold bonds on Tuesday at much higher yields than its peers but well below its 2016 highs, suggesting investors see little immediate threat of default.
Liaoning is the only province in China in recession and is viewed by analysts as a test of the central government's tolerance for ballooning municipal debt, which is fuelling wider global market concerns about China's overall credit.
The country's debt has soared to 250 percent of GDP and the Bank for International Settlements (BIS) warned in a report published on Sunday that a banking crisis was looming in the next three years.
Liaoning, the largest in China's northeastern steel-and-coal rust-belt, auctioned 19.9 billion yuan ($2.98 billion) in bonds at 6 to 14 basis points (bps) above a lower limit set under auction rules, traders said.
That is well below the 30 basis points that Liaoning paid earlier this year, but significantly higher than auction results from other provinces in the past two weeks.
Shaanxi province auctioned bonds earlier on Tuesday at par to 1 bps above the lower-limit benchmark, while the city of Ningbo auctioned debt last week at par to 4 bps above.
The lower limit is calculated as the average yield of central government debt of the same duration over the past five business days, according to the auction rules.
The Liaoning provincial Ministry of Finance had no immediate comment.
Investors have been watching Liaoning, which is facing population flight, rising debt levels, and a string of defaults by provincially owned steelmaker Dongbei Special Steel Co Ltd, for hints of stress in China's growing municipal bond market.
Tax revenues in the province plummeted by 35 percent in 2015 and its debt-to-revenue ratio approached 300 percent.
Although few analysts believe Beijing will allow a province to directly default on its debt, some say that weak investment and a falling population mean Beijing may have to intervene far more aggressively to prop up the provincial economy.
"Some local governments in the northeast suffer from a widening fiscal deficit and recorded a (year-on-year) decline in growth in 2015," analysts at ratings agency Fitch said in a research note.
"Shrinking demand in industrial sectors, commodity over-supply and a subdued real estate market push their tax revenue to a record low. These governments' fiscal strength is aggravated because a bigger commitment in education and social security in these regions increases their operating expenditure."
China's municipal debt - much of it to refinance expensive off balance sheet debt raised in the wake of the financial crisis - has mushroomed in the past year and a half.
Municipal debt issuance reached 4.8 trillion yuan (553.25 billion pounds) in year-to-date in August, official data shows, more than the entire amount issued in 2015.
Liaoning's auction results suggest investors see little threat of an immediate default, although its bonds trade at a sharp discount to the debt of most provinces.
The provincial government also owns Dongbei Special Steel Co Ltd, whose default in late March contributed to a sell off in China's corporate debt market in April.
Following multiple defaults by Dongbei in 2016, creditors in July took the unusual step of asking underwriter China Development Bank to urge regulators to block Liaoning province from issuing further debt.
China Development Bank said in a later statement that it would continue to support the economic development of Liaoning and other northeastern provinces.
Online financial magazine Caixin later cited comments by a Chengxin Credit Rating report saying that Dongbei's consecutive defaults and the passive stance of the provincial government on the issue could damage the overall credit market in Liaoning.
Liaoning's auction was its first since mid July, before the actions by Dongbei creditors and Chengxin.
(Reporting By Nathaniel Taplin; Editing by Kim Coghill and Neil Fullick)