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…
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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.