Attentive readers may remember that in March this year our eye was caught by some references in the World Bank’s quarterly update on China’s economy to the strain on local government finances, and particularly on the way provincial and municipal officials were using captive commercial investment companies to get round prohibitions on borrowing. Going off-budget via these urban development and investment corporations that can borrow for their own account has helped finance large-scale urban infrastructure across the country, but also amounts to a potentially large and sketchy pool of debt that is exacerbating fears about bad debt in the banking system.
The concern is that these investment getarounds, of which there are an estimated 3,000, won’t generate sufficient returns to pay operating and interest costs or to repay the loans taken on, leading to a rise in non-performing bank loans, especially at smaller (and weaker) regional and local banks, or leaving local governments holding the can. One estimate the World Bank quoted puts the size off this murky off-budget liability at 9 trillion yuan ($1.4 trillion) equivalent to nearly 30% of GDP.
Beijing has been trying to tighten up administratively on such circumnavigational financing but has also been experimenting with provincial government bond issuance to bring this borrowing into the light and subject it so the disciplines of the markets. A working paper from the World Bank, seemingly published internally in April, as it happens, but now being made public, outlines a new regulatory framework for doing so.
It is a detailed, technical read, addressing the rules and market structures necessary to improve fiscal transparency, impose sound budget and financial management, lessen credit and macoeconomic risks and deal with insolvencies. But it does give a clear view of what a China munibond market could, and may well, look like.
We are convinced it will happen. Sales of land-development leases are a larger source of revenue than taxes for most local governments. That is an unsustainable way to develop the country’s infrastructure. The need to increase and diversify the revenue of local governments so they are less reliant on volatile land transactions is pressing. Beijing doesn’t have the tax money to hand over. That means giving provinces and municipalities more direct access to capital markets.