Sunday, 18 October 2009
RMB 4 Trillion Stimulus vs RMB 5 Trillion Debts: Looming Local Government Credit Risk Explosion
For the implementation of China’s four trillion yuan economic stimulus, the central government requires matching funds by local governments “100%” in place. Local governments already in financial difficulties are finding these requirements especially onerous, but are now being allowed to issue special bonds to come up with the cash. A problem: Will local governments ever be able to repay the five trillion yuan of bonds they have issued?
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RMB 4 Trillion Stimulus vs RMB 5 Trillion Debts: Looming Local Government Credit Risk Explosion
By CSC Staff, Shanghai
18 October 2009
For the implementation of China’s four trillion yuan economic stimulus, the central government requires matching funds by local governments “100%” in place. Local governments already in financial difficulties are finding these requirements especially onerous, but are now being allowed to issue special bonds to come up with the cash. A problem: Will local governments ever be able to repay the five trillion yuan of bonds they have issued?
“The massive issuance of city investment bonds this year looks to trigger risks in the future,” says Xu Lin, director of the Finance Department of the National Development and Reform Commission (NDRC). He says that, because of the needs of the economic stimulus plan and the lack of local financing channels, NDRC can only maintain the development of city investment bonds through improving the existing regulatory system.
The current national tax system shorts local governments of funds, and the Budget Law also clearly stipulates that “except as otherwise provided in the law and by the State Council, local governments are prohibited from issuing local government bonds.” The city investment bond, also known as “quasi-municipal debt,” is a kind of corporate bond and medium-term note issued publicly for local infrastructure or public projects, with the local financing platform as the main issuing body.
Local governments have a strong incentive to use these bonds to plug the four trillion yuan funding gap. Since the Finance Ministry’s issue of bonds worth 200 billion yuan on behalf of local governments is clearly insufficient, local governments choose to issue “quasi-municipal debt” relying on “leasing the government’s credit.” These so-called “municipal bonds” are issued by local governments and their authorized agents, secured by the credit of local governments, and the funds raised are mainly channelled to urban public facilities. This is a mature financing instrument in Western countries with a long history. But in China, there has never been a municipal bond in the real sense. These city investment bonds issued by urban construction investment companies affiliated to government are known as “quasi-municipal debt.”
Since the central government’s implementation of its stimulus plan last November, four blocks of funds have been issued, of 100 billion, 130 billion, 70 billion and 80 billion yuan, respectively. NDRC plans to issue the fifth central investment this month. 550 billion yuan have already been issued by the central government this year, and local governments and banks are required to invest a corresponding total of 1.18 trillion to back the package. At present, the operation of matching funds from most provincial governments is running smoothly, but the situation is different when it comes to cities and counties due to their financial weakness.
The central government is allowing the proceeds of land sales to be used for investment matching for the first time, but many local officials complain land sales revenues have already been slated for supporting projects, or that income from land sales contributes nothing.
During the first eight months of this year, 64 city investment debts have been issued, totalling 84.55 billion yuan, while over the past four years, from 2005 to the end of 2008, the total amount issued amounted to only 158.5 billion yuan.
“We must pay attention to the potential risk caused by excessive debt issuance,” Xu Lin stresses. Some actions in the course of issuance, e.g. “excessive packaging” before issuance, “false assets” and “false profit” claimed by city investment companies to meet provisions of “Company Law,” heighten the risk.
In addition, “non-objective” assessments given by ratings companies to reduce apparent risk actually increase it for investors. Local governments lack debt repayment capacity and their promises of upgrading the credit rating of city investment bonds must be greatly discounted.
The latest central bank statistics show that there are more than 3,800 local financing institutions managing the total assets of 8 trillion yuan to date, but local government debts have reached 5 trillion yuan.
It was rumoured that NDRC would introduce new regulations for city investment bonds in the first half this year. It was said that the rating of the issuance body for city investment bonds would need to be at least “AA-”, and the bond should meet “AA +” level. Xu Lin says many issuing bodies were simply not qualified. He adds, “Maybe we can learn from the US practice for local government credit risk. If the local government’s debt exceeds 150% of revenue, a city investment bond cannot be issued.” Xu Lin says a warning line for government debt is essential.
However, the obvious premise of this approach is that local governments have a balance sheet. Domestic local governments have no such balance sheet, making the implementation of the 150% warning line illusory or meaningless. A report from the Research Institute for Fiscal Science of Ministry of Finance Institute estimates the domestic debt balance of local governments at the end of 2007 was about 4 trillion yuan, accounting for 143.7% of local governments’ revenue.
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