UPDATE 2-China signals green light for local govt bond sales in 2014 to curb debt risks

Tue May 20, 2014 1:53am EDT

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BEIJING May 20 (Reuters) - China's cabinet signalled on Tuesday it is closer to letting local governments directly sell bonds for the first time and said it would phase out opaque financing vehicles that are thought to have built up trillions of dollars of high-risk debt.

In a sweeping statement, the country's top economic planner, the National Development and Reform Commission (NDRC), said Beijing would deliver stable economic growth whilst pursuing reforms.

The promise to stay focused on reforms would appease critics who worry China's enthusiasm for bringing about painful changes may be on the wane as its economy stumbles.

The uncertain outlook for the world's second-largest economy was underscored on Tuesday by remarks from a senior Chinese trade official, who said the country has a tough road ahead if it wants to meet its 7.5 percent trade growth target this year.

Yet the NDRC said in a statement on its website that enacting change is a "first priority" for the government and hopes to make breakthroughs this year in key areas.

On fiscal reform, which caused a market stir on Tuesday after Chinese media reported that China would allow 10 local governments to directly sell municipal bonds, the NDRC signalled that the government won't disappoint investor expectations.

It said China will create a financing system for local governments that will let the sale of municipal bonds be a major source of funding for governments.

Financing vehicles, which are set up by local governments to borrow on their behalf so as to get around laws that prohibit governments from borrowing directly from any parties, would also be phased out.

It said that Beijing would set limits -- or quotas -- on the amount of debt that can be raised by local governments.

"The policy has been made talked about several times, so the market is now waiting for details, in particular how the quotas will be set," said a senior trader at a major Chinese state-owned bank in Shanghai.

"I don't think the central government will immediately let local governments issue lots of bonds and endanger the overall financial system."

A LONG-TERM SOLUTION

According to Chinese media, China is set to allow the 10 governments that include Zhejiang, Jiangsu, Shandong, Guangdong, Beijing, Shanghai and Shenzhen to directly sell municipal bonds.

Tuesday's statement did not refer to the above plans, though many analysts have said that the only viable, long-term solution for China with regards to its local government debt problem is to develop a thriving municipal bond market.

By allowing direct bond sales, Beijing can require higher degrees of disclosure in prospectuses and can also allow for the distribution of risk to a wider pool of potential investors.

Chinese local governments at present have limited legal options for fund raising, but have proven nimble at exploiting loopholes.

In addition to selling land to raise funds, they have created local government financing vehicles which have gone to the bond and loan markets to raise funds.

Local Chinese governments, which are notorious for being opaque, are estimated by some analysts to owe up to $4 trillion - 42 percent of China's GDP - much of it raised through financing vehicles.

A state audit of local governments' debt in December showed they owed a total of $3 trillion as of June 2013.

But despite concerns about the fiscal health of local governments, bonds sold by their financing vehicles are still sough after by investors. This is partly because many believe they are implicitly guaranteed by the state, even after Beijing allowed the country's first publicly-traded bond to default this year.

Other reforms canvassed in the NDRC guidelines included repeating commitments to a more market-oriented exchange rate, cutting red tape and deepening energy reforms.

"We should seize this time window when the overall price level is stable to actively push price reforms in resource products and sectors including transportation, telecommunications, pharmaceutical and healthcare industries," the NDRC said. (Reporting by Aileen Wang and Koh Gui Qing in BEIJING and Pete Sweeney and Lu Jianxin in SHANGHAI; Editing by Kim Coghill)

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