Using muni bonds may risk new problems
Print Edition
CHINA is asserting control over once-chaotic local government financing by banning the use of opaque funding vehicles, but filling the gap with a huge expansion of the fledgling municipal bond market will raise a whole new set of problems.
Chastened by promiscuous local investment in response to the 2008 global financial crisis, Chinese government wants to restore discipline as part of its wider economic reforms, but the muni bond market, bedevilled by price distortions and inadequate disclosure standards, is no quick fix.
China’s State Council barred local government financial vehicles from raising funds on behalf of local authorities in a decree issued earlier this month.
On Tuesday sources told Reuters the Ministry of Finance had circulated a draft document saying localities would be allowed to issue new muni bonds to pay off old debt.
“It’s not an isolated move — rather it’s part of a systematic approach to tackle the local debt issue,” said Bank of America-Merrill Lynch China strategist Tracy Tian.
Increase in quota
If the draft becomes law and localities are allowed to roll over a substantial portion of their estimated 18 trillion yuan (US$3 trillion) of outstanding debt, the muni bond market would have to expand dramatically from the quota of just 109.2 billion yuan that central government has set for 2014.
“We estimate that as much as 1 trillion yuan of new bonds may be issued to fill the financing gap in 2015,” wrote UBS economist Tao Wang in a research note this month.
The market appears ill-equipped for such explosive growth. It got off to a dubious beginning in 2014, with impoverished and debt-ridden local governments able to issue bonds at yields below even the central government’s sovereign yield.
Analysts blamed high ratings from compliant domestic ratings agencies and possible collaboration between issuers and the state-owned banks that dominate the market.
They also noted that offer documents for such issues lacked proper disclosure, usually doing little more than parroting the provinces’ five-year plans.
Only province-level governments will be allowed to issue bonds, making thousands of lower-level city and county authorities dependent on provincial governments for their funding.
“With key players starved of money, a vicious competition may emerge between cities and counties over the distribution of the proceeds of provincial bond issues,” said a trader at a Chinese commercial bank in Shanghai.
While making lower-tier governments work harder to justify spending would be no bad thing, it could create big problems if the process is not handled efficiently, he warned.
Tackling risk-pricing distortions could also prove tough, since few domestic investors believe Beijing would really allow a province to default on its bonds, and the wording of the State Council decree suggests the central government will play an active role when defaults threaten.
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