Banking & Finance

Local relief

Beijing allows municipal bonds after a 20-year hiatus


Wrote the book on local government misdemeanours: Zhu Rongji

When Zhu Rongji was appointed vice premier in 1993, central government revenues were a paltry 12.6% of the economy – the lowest among the major economies – and less than half of local government’s combined fiscal take. The Ministry of Finance (MoF) even had to borrow money from the provinces in some of its more cash-strapped moments.

Local governments were also allowed to appoint regional banking executives, which led to runaway lending and surging public debt. A tangled web of credit known as “triangle debts” grew between local governments, state firms and the banks. Eventually it accounted for a third of all bank loans. Another byproduct of the surge in money supply was inflation, which got as high as 17% in major cities. In May 1993 the World Bank warned that a major financial crisis was looming.

What Zhu did next was centralise fiscal power. Employing an iron-fist effort, he began to clear the triangular debts. Zhu made personal calls to the bosses of state firms, telling them to repay overdue loans. At one point he even appointed himself as governor of the People’s Bank of China so as to curb the expansion in credit.

Zhu also pushed through a tax-sharing system that tilted the balance of power firmly towards the central government in Beijing and away from the provinces. From this point on the central government collected the bulk of taxes and then redistributed the proceeds to the localities. To rein in local governments further, Zhu banned them from issuing bonds in 1993. A year later a new budget law prevented municipalities from running fiscal deficits.

Zhu staved off financial crisis but a consequence of his crackdown was that local governments were starved of revenues. To balance the books they were forced to sell land to property developers. Thus a new problem was created: local governments were soon in thrall to the property market. In some cities this has led to chronic overbuilding, creating a new vulnerability for the economy.

Beijing now seems prepared to decentralise some of its control over local finances. Premier Li Keqiang said in his first work report in March that an appropriate devolution was one of the State Council’s top priorities this year. To underline the intent, it was announced last week that some local governments will be allowed to sell bonds directly to investors once again – just over 20 years after Zhu first stopped them.

The MoF said last week that 10 local governments, mostly from more affluent provinces and cities including Beijing, Shanghai and Guangdong, would participate in a pilot scheme to sell bonds of their own. The maturities of the new bonds will range from five to 10 years.

The central government has been edging towards a fuller reopening of the municipal bond market since 2011. Last year Beijing allowed six local governments to offer up to Rmb65 billion ($10.5 billion) worth of bonds, albeit with a catch: the central government issued the debt on their behalf. The MoF said in March it would allow a further Rmb400 billion of local government bonds to be issued this year. But this time round – thanks to the new initiative – up to Rmb109 billion of the quota will be set aside for the municipal bond pilot scheme announced last week.

According to the People’s Daily, the MoF has been responsible for the repayment of both the principal and the interest on the municipal bonds issued over the last two years. But it won’t be involved in the upcoming round of municipal debt. “Issuers will sell bonds and repay the debts directly. The central government won’t bear any liability under the new pilot scheme. It is a big breakthrough,” the newspaper said.

The National Development and Reform Commission then confirmed that the plan was for municipal bonds to replace the much-criticised local government financing vehicles (LGFVs, see WiC110 for our first mention of these funding arms). The borrowing platforms don’t appear on local government balance sheets but a national audit last December suggested more than 10,000 LGFVs had borrowed Rmb17.9 trillion, or about 32% of the country’s GDP. Many analysts think this understates the true amount of local government exposure. They also warn that a lot of the debt will never be repaid.

CBN saw other positives in the municipal bond reforms, hoping that they would encourage the emergence of objective credit ratings for China’s provinces and cities. “There will be more business opportunities for local brokerages and rating agencies, whose involvement is vital for a mature debt market,” it said. “The accuracy of credit ratings depends on information transparency. This will pressurise local governments to improve their fiscal management, as well as their related disclosures to the public.”

Beijing also seems set to change rules preventing local governments from running fiscal deficits. This requires a revision to the budget law, but faces opposition from those who worry it will be abused.

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