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Cover Stories Series 2012> Financing Tangible Growth> Archive
UPDATED: November 14, 2011 NO. 46 NOVEMBER 17, 2011
Bond Boom

A symbolic gesture

Liu Shangxi, Deputy Director of the Research Institute for Fiscal Science under the Ministry of Finance: The program is intended to raise capital for the construction of affordable homes, but it is more of a symbolic move. Since 2008, the Central Government has issued more than 200 billion yuan ($31.5 billion) worth of bonds on behalf of local governments. The latest program is not substantially different from the previous scheme because the scale of the bond issuance and its repayment method has not changed significantly. Moreover, the management of those bonds remains in the hands of the Central Government.

China still has a long way to go before allowing local governments to issue bonds autonomously. First of all, local governments need to make their debt situations transparent, including their budgets and assets. The attractiveness of those bonds depends on the credit of local governments and the strength of local economies. That is why the local governments are supposed to make their financial positions known to the public.

Meanwhile, if they independently auction bonds, local governments must be well aware of market risks and should be able to shoulder the liabilities.

To achieve that, China needs to make vigorous efforts to push forward system reforms. For example, local governments are supposed to deepen reforms to the accounting system to make balance sheets and compile financial reports of their own.

All those reforms cannot be achieved in the short term, and the central authorities still need time before giving local governments a bigger say in bond auctions.

Discipline matters

Cao Honghui, Vice President of the Research Institute of the China Development Bank: The pilot program is a positive step toward alleviating liquidity pressures facing local governments by providing them with an alternative source of funding.

China prohibited local governments from issuing bonds directly or from taking bank loans, confining such bonds to those issued by the Central Government on their behalf.

The trial use of bonds was started in regions where the economy was thriving and the government had a stronger fiscal position. Still, default risks of the bonds remain. So the policymakers must set up an effective supervision system to prevent blind and reckless fund-raising. Efforts are also required to strengthen appropriate management of the capital raised and build a financial information disclosure mechanism of local governments.

Efforts should be made to ensure that the capital raised is used to improve the livelihood of the people, such as social welfare projects and public services.

In China, local governments are not able to declare bankruptcy. As a result, once they become insolvent, the Central Government would have to step in and take over the debt burden. In a bid to tighten market discipline, the Central Government needs to impose a cap on the total size of the bond issuance and take the debt ratio as an important indicator measuring the performance of local governments. Moreover, it is necessary to establish a compensation mechanism once insolvency happens.

Fiscal conundrum

Jiang Chao, a senior analyst with Guotai & Jun'an Securities Co. Ltd.: The trial program is probably a transition before allowing local governments to sell bonds independently. This move aims to boost the war chests of indebted local governments. A large amount of their debt borrowed through financing vehicles will mature over the next two years, hence mounting financial pressures on them.

But the pilot scheme is less likely to eliminate the concern because local government bonds and urban construction investment bonds account for barely 10 percent of total local government debt. Urban construction investment bonds are issued by financing vehicles of local governments to fund roads, railways and other infrastructure projects.

I believe a root solution is to bolster the fiscal revenues of local governments and tackle their capital shortages.

It is also imperative to further improve the bond market, strengthen the transparency of local governments' debt situation and establish an effective risk warning system. Local governments should also make public their fiscal revenues and expenditures, as well as how they plan to use the proceeds of the bonds, for the information of investors.

In the future, the Central Government should give the green light for city- and county-level governments to issue bonds, and build a multi-level bond market. Meanwhile, local financing vehicles are expected to continue issuing urban construction investment bonds. But the default risks are low. Because of the bond sales, local governments will have stronger fiscal capacity to subsidize their financing vehicles.                                

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