China’s Carefully Managed Local Government Bond Issuance

Nicholas Borst (Federal Reserve Bank of San Francisco)



The 10.7 trillion renminbi in local debt revealed by the National Audit Office earlier this year has led to all matters regarding local government finances to be carefully scrutinized.

Slowing economic growth and reduced revenues from the property market mean that Chinese local governments need to borrow more money to continue their high levels of investment. Land transaction revenues, which are a critical source of funding for local governments, are down 42 percent (Chinese language) year-over-year in 30 cities across the country. Caixin recently reported that Shanghai saw a 45 percent decline in revenues from land sales, Hangzhou and Nanjing lost 30 percent, and Xian and Changsha more than 50 percent.

Aware of the growing systemic risks created by local government borrowing, the central government is reluctant for local governments to take on additional bank loans (Chinese language).

As a potential way forward, the central government approved four province-level governments—Beijing, Shanghai, Zhejiang, and Guangdong—to issue their own bonds. This is in keeping with the Chinese tradition of allowing localities to experiment with a new policy before implementing it across the whole country.

A curious thing happened when these bonds issued.  Not only were they all quickly snapped up (the Guangdong bond was six times oversubscribed) but the interest rates were below that of the national government.

While the provinces given the go ahead to issue these bonds were amongst the more financially sound local governments, objectively there is little justification for them to be able to borrow on better terms than the national government.

There are several reasons why rates were lower than should normally be expected. First, the Ministry of Finance backed these loans (Chinese language) with a guarantee. Second, non-market forces played a large role. Local government were eager for these issuances to go well and underwriters and other banks snapped up these bonds to curry favor in hopes of getting future business (Chinese language). Third, these bonds were exempted from taxes in an effort to improve their attractiveness.

Local governments’ first “independent” issuance of debt was carefully orchestrated in order to guarantee success. In many ways they differed little from the debt offerings done by the Ministry of Finance on local governments’ behalf.

While local government bonds may ultimately prove to be a positive step in developing better financing channels, this first round of bonds told us nothing in terms of the actual risk associated with local government debt. It will be interesting to see where rates go once the training wheels come off.

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