China’s local governments will for the first time be allowed to issue municipal bonds independently, according to the detailed final document resulting from the third plenary session.
The report - Decision on major issues concerning comprehensive and far-reaching reforms - released on Friday night, increases the channels through which local governments can raise funds: currently Beijing offers such bonds on their behalf and allocates the funds to them.
Beijing's report also attempts to improve the financial transparency of local governments by asking them to release their own fiscal balance sheets, instead of the current government fiscal reports, in an effort to curb their relentless borrowing.
Making balance sheets public will make the country’s fiscal situation more transparent and help rating agencies to rate municipal bonds, according to several economists.
Beijing has also agreed to support certain cross-regional public services or projects by allocating central fiscal revenue to local governments to lessen the expenditure burden on them.
The measures have delivered a clear sign from the central authorities that for the first time they are determined to clear up the country’s rapidly accumulated local debts of approximately Rmb20 trillion ($3.2 trillion).
Multiple sources said the first municipal bonds may hit the market in the first half next year. The rating system of such bonds has been in preparation and the bonds will be rated lower than the central government bonds, said one source.
The revenue and expenditure structure between Beijing and local governments is imbalanced as they currently receive about 50% of fiscal revenues from the central government but have to bear about 85% of fiscal expenditure.
To meet increasing capital requirements for development, local governments utilize funding channels including bank borrowings and bond issues through local government financing vehicles (LGFVs).
The National Audit Office in 2011 announced that the size of local government debt was Rmb10.7 trillion as of end-2010.
However, according to a September report by Nomura, the LGFV debts increased to at least Rmb19 trillion by the end of 2012, half of which may be without local government guarantees.
Market observers believe that municipal bonds will be an important financing channel for local governments. The fact that the issuers are local governments and not LGFVs will make government borrowings more transparent and standard for investors.
Investors are also worried about the hidden deficit of local governments, which threatens to spark a financial crisis. The National Audit Office found that the outstanding debt of 36 local governments was Rmb3.85 trillion in 2012, among which bank loans accounted for 78.07%, or Rmb3 trillion.
Although data show that the average NPL ratio of a Chinese bank is 0.97%, a relatively low level compared to 3.9% in the US, investors believe there are more hidden risks underlying in the financial system, according to a Moody’s report in October.
“Developing the municipal bond market will help to control the potential financial risks rooted in the local governments financing vehicles,” said Ma Jun, chief Greater China economist with Deutsche Bank.
However, like many other issues in China, the local debt problem is a multifaceted one and needs time to address.
More detailed measures on dealing with local government debt were not given in the decision document, but economists believe that policy actions and implementation will be the key to the success of the reforms.
