China’s Finance Ministry Permits Local Municipal Bond Offerings

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Trial program hopes to address local government debt problems.

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Is China getting its local government debt problem under control? That’s the question global investors asked in response to a major policy change revealed recently by the Chinese Ministry of Finance.

The ministry, which regulates China’s macroeconomic policy and national budget, announced that the central government will permit a limited trial of municipal bond offerings from four local governments for the first time since 1994.

China’s central government controls the budgets for provincial and local governments. Under China’s Budget Law of 1994 law, local governments must maintain a balanced budget. Before the announcement, only the Ministry of Finance had authority to issue government debt, prohibiting each municipality from independently levying local taxes or directly offering municipal bonds.

While the trial program represents a marked change, the program maintains the central government’s control over local governments’ finances. The four participating municipalities may only issue bonds that mature over three or five years, and the Ministry of Finance will control the size, usage, and account management functions of the bond offerings.

The new bonds will be guaranteed by the central government and will assume the credit rating of China’s sovereign debt. Standard & Poor’s currently rates China’s sovereign debt “AA-,” the rating agency’s fourth-highest level.

Because Chinese local governments could not directly issue bonds, they created as many as 8,000 investment companies and borrowed heavily from government sponsored banks to stimulate the economy amid the Great Recession. In a June 27 report, the central government estimated that local government debt from these investments totaled 10.72 trillion RMB ($1.67 trillion), or approximately twenty-seven percent of China’s gross domestic product.

Despite the central government’s new pilot program, larger concerns remain about the fiscal condition of China’s local governments and the country’s sovereign debt.  Moody’s has reported that China’s National Audit Office “understat[ed] banks’ exposures to local governments by as much as RMB 3.5 trillion,” or $580 billion.  Fitch Ratings also announced a “negative” outlook for China’s sovereign credit due to its “lending surge” and the amount of local government debt.