CHINA has been pushing local governments out of shadow banking and into the sunlight with a 2.6 trillion yuan (US$407 billion) bond program, all in the name of financial reform.

    Investors, though, seem to like it just fine in the shadows and the Central Government seems to be quietly encouraging them.

    Investors are showing declining interest in the fledgling municipal bond market — one debt auction was undersubscribed this month for the first time in 2015 — and are instead warming to the idea of lending to local governments through a back door.

    They are buying up debt issued by local government financing vehicles (LGFVs), a shady funding channel that until recently was being phased out by the Central Government in favor of the greater transparency and accountability of municipal bonds.

    Investor interest in LGFV debt, which does not appear on local governments’ books, follows the Central Government’s decision in May to reverse restrictions it had imposed only last year on these vehicles as part of a wider crackdown on shadow financing.

    In reviving LGFVs, the Central Government has conceded that the municipal bond market alone cannot funnel cash quickly enough into provincial projects to help buoy the wider economy.

    LGFVs may be shady but they are smaller and more nimble than the provincial governments operating in the municipal market. Each province has many LGFVs, which raise funds for specific projects without the administrative burden of a municipal bond.

    For investors, the allure of LGFVs is higher yields and the belief that they come with an implicit government guarantee. (SD-Agencies)