China Muni-Bond Stalling Shows Debt Threat as Party Meets

China Muni-Bond Stalling Shows Debt Threat as Party Meets

By Bloomberg News – Nov 7, 2013

Two years after China started a trial municipal-bond program, plans to take it nationwide have stalled, leaving local authorities reliant on off-budget funding through land seizures that have sparked public protests. While authorities added two provinces to the trial this year, a draft budget proposal authorizing national sales with approved quotas was dropped in June 2012 and has yet to be revived. This year’s municipal-bond issuance is equivalent to less than 1 percent of local-government borrowing as of 2010, the last official tally.President Xi Jinping has a fresh opportunity to accelerate efforts to provide more transparent funding for everything from roads to sewers in a conclave of Communist Party leaders that begins tomorrow. The danger of the current model is that keeping local-government lending in the dark elevates the risk of a bad-debt crisis, according to Fraser Howie, who wrote a book on China’s financial system.

“The longer they put off solutions, the weaker they could get in terms of their financial position,” said Howie, Singapore-based co-author of “Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise.” Developing municipal bonds “would be a very clear sign that they were serious about tackling local government finances,” he said.

Third Plenum

The four-day gathering will be the third full meeting of the party’s current Central Committee, including General Secretary Xi and Premier Li Keqiang. It was at such a third plenum in 1978 that Deng Xiaoping and his allies inaugurated a series of reforms that began to open up China to foreign investment and loosen state controls over the economy.

This year’s meeting “is expected to be a watershed as drastic economic policies will be unveiled,” according to a Nov. 4 news analysis by the official Xinhua News Agency.

The Finance Ministry, which oversees local-government bond issuance, didn’t respond to faxed questions from Bloomberg News.

October trade figures due today and data tomorrow on inflation, industrial production, investment and retail sales will give an indication of whether last quarter’s recovery is being sustained and how much room leaders have to maneuver.

Local governments’ seizures of farmland for property development have been a trigger for protests. China has 30,000 to 50,000 so-called mass incidents a year, with land disputes and environmental issues the main triggers, Chen Jiping, former vice general secretary of the Communist Party’s Committee of Political and Legislative Affairs, said in March.

Expand Market

Expanding the local-bond market is one piece in a jigsaw puzzle of fiscal and financial reforms that also include changes to interest-rate controls and a residence-registration system that limits labor mobility.

Analysts surveyed by Bloomberg News said changes to local-government funding were most urgent, when asked to choose from 11 priorities. The State Council in July ordered the most comprehensive audit of government debt in two years. Standard Chartered Plc estimates regional borrowing has increased since 2010 to as much as 24.4 trillion yuan ($4 trillion).

Expectations for action are high. Twelve of 23 respondents to the survey last month said local-government funding was one of the three most likely areas to see significant reforms in the next 12 months.

Replace Borrowing

The State Council, or cabinet, can expand the local-bond pilot program as desired, and its research arm is calling for permitting more regional-bond sales. Bond sales, under the control of the central government and local legislature, will probably be allowed to replace borrowing by local-government financing vehicles, Credit Suisse Group AG says.

“The direction is very clear: Local governments will have to follow market practices in their financing activities and investment activities,” said An Guojun, a researcher with the government-run Chinese Academy of Social Sciences in Beijing.

“At the same time, the development of a proper municipal-bond market in China depends on many other factors,” from trustworthy credit ratings to governance, said An, who served on a bond-market advisory committee to the National Association of Financial Market Institutional Investors.

Signals are increasing that authorities want to limit debt. The People’s Bank of China said in a report this week that the economy “may see a decline in leverage” over a relatively long period of time, a suggestion that UBS AG said hadn’t been previously mentioned by a government economic agency.

Spending Share

China’s local governments are responsible for 80 percent of spending while getting about 40 percent of tax revenue, the legacy of a 1994 tax-sharing system, according to the World Bank. The local share of spending has surged in recent years, causing regional authorities to rely more on land sales and borrowing via investment vehicles, Credit Suisse says.

“The government is trying to balance setting up a market and also being cautious by not allowing these local governments to start borrowing until there is a framework in place that provides adequate controls,” said Debra Roane, a Sydney-based vice president at Moody’s Investors Service who covers Asian sub-national debt.

While the municipal-bond market will develop in some form, any new borrowing channel will face difficulty because it won’t contain local governments’ power to issue debt or boost spending in “meaningful ways,” Chen Zhiwu, a former adviser to the State Council, said in an e-mailed response to questions.

“The only way out is to increase transparency through a free press and make local governments directly accountable to the local citizens,” said Chen, now a finance professor at Yale University in New Haven, Connecticut. “The problem is not that the financial engineers cannot design the right financial instrument, but a political reforms problem. Without fundamental political reforms, no financial designer has any magic.”

To contact Bloomberg News staff for this story: Kevin Hamlin in Beijing at khamlin@bloomberg.net