Beijing’s ongoing campaign to rid the country of excessive borrowing has begun to bite local governments, with reports in recent months showing a wave of defaults, which some say could have a spillover effect in the country’s onshore bond market.

The focus of the crackdown on excess leverage associated with provincial and city authorities are so-called local government financing vehicles (LGFV). Established as wholly-owned corporations to skirt restrictions on the local governments taking out loans directly, the LGFV’s have traditionally borrowed as needed to fund infrastructure and public works projects.

But the easy money is now drying up as financial regulators “are cutting off financing options to banks that do not listen to what they say,” one executive at a major commercial bank was quoted by Nikkei Asian Review as saying.

The squeeze is leading to defaults, such as one city government-controlled firm in Inner Mongolia, which reportedly failed to make interest and principal payments on around US$630 million in off-balance sheet loans.

The Asset, noting the default on several other LGFVs in Tianjin and Yunnan, reported this week that analysts are concerned about a possible bond market sell-off amid China’s moves to attract foreign investors. Quotes from sellside analysts were cited from a survey conducted by Asset Benchmark Research.

“For years, LGFV bonds have attracted investors because local or central governments will always be prepared for a bailout. However, if LGFVs are free to default, the market’s faith in LGFV bonds will be affected. The yield on LGFV bonds will increase rapidly and the negative sentiment for LGFV bonds will spread across the whole market,” said one salesperson in China. Another saw a “repricing of the whole bond market.”

“The LGFV default will cause a market sell-off,” a Singapore-based analyst covering CNY said.

Some were less concerned, noting that the impact will be limited.

“China is an important market but LGFV moves will mainly impact the onshore market,” according to a salesperson in Hong Kong.

“We think that the defaults will not have a significant negative impact on the market because the LGFV sector sports a low correlation with the sovereign sector,” said another respondent in China. “LGFVs, together with real estate, are monitored by regulators and the risks are well known.”