* Government wants bonds to be main source of municipal
* Move could create US$1.5trn market, world's second largest
* Muni bonds will reduce strain on banks
By Lianting Tu
SINGAPORE, May 21 (IFR) - China's state council this week
took a major step toward allowing local governments to sell debt
publicly, in a move that could create the second-largest
municipal bond market in the world.
The decision by the National Development and Reform
Commission could pave the way for a US$1.5trn muni market, which
would be bigger than Japan's and second only to that of the
Authorities hope that, in addition to cutting funding costs
and reducing banking risks, the move will increase transparency
by making bonds the main form of local government borrowing.
Banks and trust companies accounted for more than 56% of the
total Rmb17.9tln (US$2.9tln) of China's local government debt
outstanding at the end of June 2013, according to a recent
Deutsche Bank report.
But current annual costs can easily exceed 10% on bank or
trust funding - via local government funding vehicles used to
circumvent a former ban on direct borrowing.
Five-year municipal bonds issued under a pilot programme are
currently yielding around 4.5%, only about 50bp higher than
central government paper with similar maturity.
The very low yield of these few bonds, though, may be partly
attributed to implicit government guarantees.
Rolled out in 2011, the pilot programme allowed a few
municipalities to sell bonds directly.
While they sought their own underwriters and conducted
auctions, the finance ministry was still making the payments on
the bonds on behalf of the local governments.
Under the new plan, local governments will pay coupons
directly, which could mean that investors could demand higher
Even if yields rise however, the average funding costs
should be lower than what local governments currently pay,
according to Robert Zhang, an analyst with Standard & Poor's.
The development of a municipal bond market will also help
Beijing shed light on what has become an increasingly murky
Municipal bonds are currently the most transparent type of
local government debt in China, as financial information and use
of proceeds have to be detailed and disclosed publicly, the
Deutsche Bank report said.
The new plan is expected to require even more comprehensive
financial statements from local governments, including
additional details on assets and liabilities.
"The has been working on those financial
statements for the last two years," Zhang said.
"But at this stage, it is still unclear exactly how much
information will need to be disclosed."
Shifting local government borrowing to the bond market is
also expected to reduce the strain on the banking system.
It is "good for the economy, because banks are able to
better allocate their assets in the longer term as they lend
less to the local governments", Zhang said.
NOT SO FAST
Full rollout of the new scheme will not happen right away
and, for now at least, Beijing is expected to increase the bond
quota for local governments to grow the market.
That quota had already been raised to Rmb400bn this year
from Rmb350bn in 2013.
"In order to have a healthy municipal bond market, the
Chinese government needs to offer more ways for local
governments to raise revenue - such as collecting property tax -
in addition to land sales," said Taimur Baig, chief economist
for Asia at Deutsche Bank.
"Also, the central government needs to offer healthy
incentives to the local governments, such as a lower target
growth rate and more autonomy."
China will also need to enforce discipline among local
governments - and reassure the market by offering some guidance
on what happens in case of default.
"Chinese municipal bond markets will be different from the
US, because China is a unitary state and the central government
will balance the reputation of government and the need to
discipline the local governments," Zhang said.
(Reporting by Lianting Tu; Editing by Christopher Langner, Marc