A Step Forward for Chinese Local Government Debt
The Guangdong government announced on June 23 that it had issued RMB14.8 billion in municipal bonds, comprising RMB5.92 billion of 5-year bonds at an interest rate of 3.84 percent, RMB4.44 billion of 7-year bonds at 3.97 percent, and RMB4.44 billion of 10-year bonds at 4.05 percent.
Guangdong is the first participant to issue municipal bond issuances after the central government gave the green light to a RMB109.2 billion pilot program to 10 provinces and cities on May 21. The other nine provinces and cities are Shanghai, Zhejiang, Shenzhen, Jiangsu, Shandong, Beijing, Qingdao, Ningxia, and Jiangxi. They are expected to issue municipal bonds in the near future.
The Guangdong government was assigned an AAA rating by Shanghai Brilliance Credit Rating Agency based on an assessment of its outstanding bonds, macrofundamentals, economic growth, fiscal balance, debt conditions, and governance. The rating reflects the agency’s confidence on Guangdong's repayment capacity, strong fiscal buffer, and low default risk.
Municipal bond issuance is a signal that China’s bond market is entering a new era. Direct bond issuance creates a new revenue source for local governments, alleviating their overdependence on proceeds from the real estate sector. Direct bond issuance also eases the financial pressures of having to support the central government’s urbanization initiative, including new large-scale infrastructure projects. Compared with bonds issued at the interbank market by local government debt facilities (LGDFs), municipal bonds are a more transparent and responsible long-term solution for local governments.
There are, however, significant market concerns regarding the new municipal bond market. The government has not disclosed the usage of the funds raised in this issuance, leading to difficulties in public follow-up on fund usage and repayment. The situation is expected to improve gradually. Minister of Finance Lou Jiwei has made greater budget transparency a priority for fiscal reform in a recent speech, following the circulation of the draft of “Deepening Fiscal and Tax Reform.” A pilot program on transparent budgeting started in Shandong, with the target goal of disclosing budget plans of local governments above the town level by 2015.
Another concern is the lack of information on the overall fiscal position of the Guangdong government. The National Auditing Office (NAO) should have statistics after its national investigation late last year but does not. Without a clear statement of the outstanding fiscal debt of local governments, it is hard for investors to evaluate risks fully.
The issue is also linked to the credit rating system: Awarding an AAA rating to Guangdong without a clear statement on the debt conditions affects the system’s credibility. Therefore, opening a new door for local governments to issue bonds might cast more concerns on their debt sustainability if clear supervision is missing. The central government is likely to release new measures on this issue in the coming years. For example, the central government could set a clear debt-to-GDP cap of around 40 to 60 percent as a discipline for local governments, and set punitive measures for those with overly high outstanding debt.
Despite these concerns, the new municipal bond program is a meaningful step in the process of fiscal reforms and contributes to sustainable fiscal balance in China.