DEBT MOUNTAIN: The yet-to-be-finished Cuntan Bridge on the Chongqing-Lichuan Railway. Local governments have borrowed a load of debt to finance a spending spree on infrastructure (CAO NING)
The Ministry of Finance recently kick-started a pilot program allowing local governments of Shanghai and Shenzhen, and Zhejiang and Guangdong provinces to issue bonds for the first time. How will the new policy affect fiscal capacities of local governments and the broader economy? What else should the country do to build a healthy bond market? Economists and experts discussed these issues in an interview with the Shanghai Securities Journal. Edited excerpts follow:
Zong Liang, Deputy General Manager of the Strategic Development Department of the Bank of China: The trial program is a solid step as the country puts proactive fiscal policies in place to avert a deeper economic downturn. The Chinese economy is facing some downside risks, so the country is sparing no effort to strike a balance between taming inflation and maintaining growth.
The new policy is bound to deliver a boost to local governments' financing abilities, and thus sooth their financial pressures. As China's local governments were not allowed to directly acquire loans or issue bonds, many have borrowed a mountain of debt through special investment vehicles. Obviously, issuing bonds would help them honor those obligations.
As part of the country's proactive fiscal policies, the program will inject some fresh steam into the economy. Most importantly, it will make local government debt more transparent, and in part replace many financing vehicles as a source of capital. If further expanded to the entire nation, it will also help expand the country's bond market and increase the market's scale and depth.
Nevertheless, it is unlikely to completely address the indebtedness of local governments. The Central Government ordered that bonds of the four local governments should not exceed 22.9 billion yuan ($3.6 billion) in 2011, which is only a small drop in the ocean of enormous local government debt. So a more permanent solution is to rebalance the growth model of local economies and shore up their fiscal positions.
It is an inevitable trend to expand the trial scheme to the entire country, but that depends on increased efforts to optimize the market system. A healthy bond market should have a reasonable pricing scheme, independent credit rating agencies, as well as mature secondary markets.
As the local governments have varied demands for financing, it is necessary to allow more municipal governments to sell bonds. In that case, the fund-raising scheme can be more flexible.
Sheng Hongqing, chief macroeconomic analyst with the China Everbright Bank: China plans to build more than 36 million affordable homes during the 12th Five-Year Plan (2011-15) period. Financing became a problem amid a tightening monetary environment. So proceeds of the bonds are likely to be used to finance these housing projects.
There are also growing concerns that the Chinese banking system may be at risk because many local governments have obtained a load of loans through financing vehicles over the past three years. So the trial program could relieve some pressures piling on their asset quality.
The Ministry of Finance said it will pay the principal and interest on the bonds to investors after the debt matures, and the local governments then repay the ministry. That means local governments still cannot decide for themselves how to proceed with bond issuance. If allowed to issue bonds independently, local governments should be able to determine the amount of the bonds according to their needs. Credit ratings are also needed to reflect creditworthiness of the bonds and the fiscal strength of local governments.
China should further expand the pilot program to more regions in the country and promote municipal bonds. That would be a needed boon to restrict the local government's financing vehicles and reduce financial risks. In relatively developed east China, many cities and counties have stronger fiscal capacities than those in western provinces.