* Explosion in local govt debt on agenda for reform meeting
* Govt think-tank favours expanding municipal bond market
* Current pilot project is tiny but shows promise
* But some worry that municipal bonds would only worsen debt
By Gabriel Wildau
SHANGHAI, Oct 21 China may decide next month to
expand a trial programme allowing local governments to sell
bonds, in response to concerns that their huge borrowings are
largely hidden from view and pose a risk to the stability of the
nation's financial system.
A government think-tank that advises China's cabinet, the
Development Research Center, has put forward a proposal calling
for greater use of municipal bonds ahead of a policy-making
meeting next month to decide Beijing's long-term reform agenda.
Local government debt totals up to $4 trillion or 42 percent
of gross domestic product, according to some unofficial
estimates, but much of it has been raised via financing vehicles
that do not disclose details on the size and health of loans.
That lack of transparency - akin to the kind of off-balance
sheet lending that froze international debt markets and led to
the 2008-09 global financial crisis - could be addressed through
use of bonds, which require disclosure and spread the risk of
default across a wide array of investors.
"'Open the front door, block the back door,' and expand the
scope of local government independent bond issuance," the
Development Research Center said in its draft proposal submitted
recently to leaders of the ruling Communist Party and published
last week on the website of Beijing's Renmin University.
Chinese law bans local governments from selling debt
directly in a measure that was meant to restrain their
borrowings, but local officials have skirted it by raising debt
through financing vehicles to fund infrastructure projects.
Borrowing through so-called local government financing
vehicles (LGFV) exploded in 2008-09, when China pumped 4
trillion yuan ($656 billion) in stimulus spending through the
economy to cushion the impact of the global financial crisis.
"The rise in local government debt is ... a concern, given
the complexity and opacity of municipal finances," the World
Bank warned in a regional economic update this month.
"This lack of transparency has led to debt levels higher
than would otherwise be acceptable to lenders, investors and
Many reform advocates hope new policies announced during the
party's Third Plenum in November will include aggressive
expansion of a pilot municipal bond programme launched in 2011.
They argue that local governments' current reliance on bank
debt and loans from trust companies - another form of opaque
lending - contributes to profligate local spending. The use of
LGFVs adds to the opacity.
Economists say a real municipal bond market would be key to
addressing the local debt issue, with disclosure requirements
helping to impose a hard budget discipline on local officials.
In another sign authorities are poised to expand municipal
bond issuance, another influential think tank, the China Academy
of Social Sciences, teamed up with a major credit ratings agency
last month to issue ratings of local governments.
LOWER COSTS, BETTER FIT
The local bond pilot remains tiny compared to the scale of
local financing needs. The finance ministry in March set a quota
of 350 billion yuan ($57 billion) under the programme for 2013.
Still, bonds have been well received by investors and yields
have hovered around 3.8 percent to 4.5 percent, nearly as low as
Chinese treasury bonds of the same maturity.
By contrast, weaker localities forced to resort to
trust-company loans and other sources of shadow-banking finance
often pay more than 10 percent annual rates.
That suggests expanded bond issuance could enable many
localities to cut borrowing costs.
The use of longer-term municipal bonds could also relieve
the worrying mismatch between infrastructure investments that
may take decades to produce financial returns and the short-term
loans that are often used to finance such projects.
"Take a highway project as an example. It may take 20 or 30
years after it's built to repay principal and interest. But the
bank loans are typically three to five years," Wu Xiaoling, a
former Chinese central banker, told Reuters last month.
But low yields on the small pool of existing municipal bonds
may simply reflect investors' assumption that the finance
ministry has chosen fiscally strong localities for the pilot.
"If you suddenly let everyone issue bonds, then the market
no longer sees it as a special privilege. So then the market
will have to go back to looking at fundamentals," said a bond
analyst at a mid-sized fund management company in Shanghai.
Chinese media quoted Finance Minister Lou Jiwei last month
as calling for "gradually forming a standardised local
government debt financing mechanism based mainly on municipal
The question is what "gradually" means.
The results of an official audit of local government debt,
due this month, could determine whether the bond pilot is
expanded or left to wither.
The last audit showed local debt at 10.7 trillion yuan
($1.76 trillion) at end-2010, though it used a narrower
definition of local debt than that used by banks such as
Standard Chartered which see it as high as $4 trillion.
A dramatic rise could make authorities balk at expanding the
Official media quoted an unnamed audit officer last month as
saying the new audit may show local debt nearly doubling between
2010 and 2012. The article was later deleted from the website of
Economic Information, a newspaper run by the official Xinhua
Indeed, some in the finance ministry worry that allowing
more municipal bonds would only fuel local officials' appetite
for borrowing, making the debt problem worse. Such caution has
led most analysts to predict that authorities will permit only a
modest expansion of the bond pilot.