China Said Set For Big Boost To Muni-Bond Market

China looks set to give a big boost to its nascent muni-bond market this year. The Finance Ministry is to quintuple the quota for local government bond issuance to 250 billion yuan ($40 billion) this year, Caixin reports.

In addition, more provinces will reportedly be added to the list of those able to issue bonds directly. Since 1994, the ministry has done that on behalf of local governments but started an experiment in direct issuance in October last year with Shanghai, Shenzhen, Guangdong and Zhejiang. That privilege will be extended to six more provinces and municipalities. The ministry is expected to maintain the close control over the bond issuance by the larger group that it has exercised over the trial quartet, including having a big say over what the funds raised can be used for.

Expanding the muni-bond market is both part of the broader reforms of the financial system and local government finances. The latter are teetering under the burden of 10.7 trillion yuan of debt, at least 3 trillion yuan of which falls due by the end of this year. Much of the debt piled up as a result of the stimulus spending in the wake of the 2008 global financial crisis. Much of it is infrastructure loans, for things like toll roads to nowhere, that are weighing heavily on the creditworthiness of China’s banks.

Earlier this month the China Banking Regulatory Commission ordered banks to clean up their balance sheets with regard to local government lending. It first told them to do that in June last year, but progress clearly hasn’t been rapid enough, or, as a result of the cooling of both the economy and the property market, problem loans are mounting. Good and bad loans alike were probably rolled over when banks tackled the 2 trillion yuan of local government loans that fell due last year. Another red flag raised by China’s audit office: irregularities it has found with 530 billion yuan worth of the lending. Taken together, an estimated 2 trillion-3 trillion yuan of local government lending has soured, which would be sufficient to raise the banks’ non-performing loan ratios to 5% from their current average of 1.1%.

The new quota of 250 billion yuan for bond issuance won’t wipe away the problem but every little bit helps–though places like Greece serve as a reminder that bond issuance is not an infallible inoculation against the highly contagious disease of government fiscal profligacy. Yet while the immediate priority is to deflate China’s local-government debt bubble before it can go damagingly pop, an expanded muni-bond market also pushes provincial and municipal governments in three other desirable directions: less reliance of land sales to raise revenue, less need for the off-balance sheet financing via captive investment vehicles that local authorities have resorted to get round restrictions on official borrowings, and more transparency generally about their finances.

China’s Nascent Local-Government Bond Market

Since Beijing took greater central control over tax revenues in 1994, there has been fiscal-system asymmetry between the centralized administration of revenue, which is parceled up and sent back to local authorities as transfer payments, and the decentralized responsibility for spending that had been given to the provinces in the 1980s. More than two-thirds of spending is in the hands of provinces, prefectures, counties and townships, with central government controlling the balance. The transfer payments subsidize some of that spending in all provinces, up to half of it in the poorer ones.  It is a rudimentary way of managing public finances and one that has left a mish-mash of local-government financing vehicles to circumvent the system, including captive commercial investment companies though which local governments borrow. There are an estimated 3,000 of these across the country, some on creakier footings than others.

Provinces have been given only limited authority to tap capital markets. In the Asian financial crisis and again during the 2008/09 global financial crisis Beijing sold bonds through the finance ministry on the provinces’ behalf. Last year 200 billion yuan ($29 billion)-worth of bonds were issued by provinces such as Anhui, Guangxi, Heilongjiang, Inner Mongolia and Jilin. Beijing funded less than a third of its 4 trillion yuan stimulus package directly and relied on the provinces to find the rest. The size of each bond issue was determined by the capital needs of each province, which favored central and western provinces, which would not have been the case if conventional credit scoring had been employed.

Reports in the 21st Century Business Herald (via Bloomberg) say that provincial governments are to be given more freedom to access capital markets under new rules being drafted by the State Council. These have partly been inspired by Beijing’s growing concern about local-government borrowing growing out of control.  Two-fifths of last year’s  9.6 trillion yuan in new bank loans went to local governments. And there are similar concerns about the fast growth of non-loan debt. Thus greater freedom to issue bonds will  come at a price: tight restrictions on extra-system financing through local governments’ investment units.

While the immediate priority is to clean up and rein in local government debt growth before it becomes another bubble, the development of a local-government bond market is in Bejing’s long-term plan for developing financial markets. However, it will move slowly. Beijing is wary of giving provinces more control over their own development, at the expense of central control. It 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. 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.

China To Get A Muni Bond Market

In the wake of the Asian financial crisis a decade ago, China dabbled with issuing local government debt to fund local projects. Come another financial crisis, and the idea is being dusted down again.

Officials have reportedly been discussing a tentative plan to sell some 200 billion yuan ($29 billion) of bonds through the Finance Ministry this year to finance provincial and municipal stimulus spending on infrastructure projects such as airports, power plants and railways. Six provinces and municipalities,  including Beijing, Shanghai, Tianjin and Chongqing, have been earmarked to lead the experiment, according to the South China Morning Post.

Local governments’ fiscal revenues fell 2.7% to 316.7 billion yuan in January (central government’s were down 28.4%), the finance ministry has reported, thanks to tax cuts and a slowing economy. Land sales, a mainstay of local government budgets, have also dried up, leaving provinces and cities strapped for cash, and relying otherwise on city and provincial-owned companies to raise bank loans. This mechanism could mask local government debt equivalent to 10% to 20% of GDP on some estimates, similar to central government debt’s share.

The proposed bond issues would make this debt more transparent, and may have a life long after the current crisis — and the need to pump prime the economy — has passed.