China’s Muni-Bond Market Brought Back To Life

This Bystander noted last year that moves were afoot to develop a municipal bond market as a way to put the financing of provincial and local governments on a more transparent footing, and to wean it from the off-balance sheet financing via captive investment vehicles that local authorities have resorted to get round restrictions on official borrowings. As of June, 2010, these captive investment vehicles accounted for 7.7 trillion yuan of local government borrowings (more than three-quarters of the total), and had become some of the most riskiest parts of local government finances in the eyes of the finance ministry.

Now, Zhejiang and Guangdong provinces and the municipalities of Shanghai and Shenzen have been given permission by the ministry to issue three- and five-year bonds on a trial basis. It is the first such direct muni-bond issuance sanctioned in 17 years.  Collectively the quartet are expected to be capped at 20 billion-30 billion yuan first time round. (Update: Shanghai, 7.1 billion yuan; Guangdong, 6.9 billion yuan; Zhejiang, 6.7 billion; and Shenzhen 2.2 billion yuan.) That would be one-tenth of the annual issuance now made by the finance ministry on behalf of local governments to help meet funding shortfalls.

Though the bonds will issued by the four authorities, they will be closely supervised by the ministry. The proceeds of the sales will be kept in a special account at the ministry, which will oversee the payment of interest and principal, and, in effect, guarantee the bonds. The ministry will also have a big say in what the money raised can be used for. Zhejiang is expected to be first out of the gate, raising funds for infrastructure projects. If all goes well, other provincial and city governments will be allowed to follow suit.

Beijing banned local governments from selling their own bonds–and from running deficits, come to that– in 1994 when it became concerned local authorities were running up huge debts they wouldn’t be able to pay. Now policymakers are concerned that local authorities have again borrowed too heavily in the wake of China’s post-2008 global financial crisis stimulus, and that in a slowing economy and cooling property market they will again struggle to repay their loans. Worse, that could trigger a banking crisis.

While the immediate priority is to clean up and deflate the local government debt bubble before it can go damagingly pop, the development of a local-government bond market is in Bejing’s long-term plan for developing its domestic financial markets. Beijing is moving cautiously, however. It remains wary of giving provinces more control over their own development, at the expense of central control. The initial quartet are trustees, so to speak, and financially sound enough to test the waters without too great a risk of mishap.

Beijing will still have to guarantee the debt of many provinces for sometime to come, and there is a real risk that some of the weaker provinces won’t able to maintain their debt service. As Liu Mingkang, head of the banking regulator, noted earlier this week, there are serious concerns about the levels of local government debt. “We cannot deny that local government financing platforms have not been managed well,” he said.

A quick glance west to Greece or east to California reveals the trouble fiscally wayward and heavily indebted national and local governments can get into. Having prided itself on avoiding the worst excesses of the prelude to the recent global financial crisis, Beijing doesn’t want to go there in its aftermath.

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