Chinese municipals: Attacking the mountain with a pin
Many of China’s provincial and municipal authorities are in financial trouble; a new bond issuance programme won’t help in the short run.
Four of China’s local governments are to be allowed to issue bonds directly to the market in a trial programme that ends a 17-year hiatus on such issuance. The provinces of Zhejiang and Guangdong, and the municipalities of Shanghai and Shenzhen, will be the first in a programme that allows governments to raise funds directly rather than relying on local government finance vehicles (LGFVs) in which debt is issued against assets such as land and infrastructure.
The news has been hailed in some quarters as a positive development in view of the fact that at least some of China’s local governments are in serious financial trouble. Encouraged by the post-crisis stimulus plan to launch many infrastructure and development projects, they spent heavily and financed borrowing against assets that in many cases are not yet yielding returns. The LGFV bonds have traded poorly this year amid suspicion that the problem is worse than is generally thought or admitted in China.
So a new bond issuance programme to the rescue, right? There are reasons to be cautious. First, analysts reckon the four authorities cleared to issue bonds in the pilot scheme are among those in the best financial position in China, and therefore least in need of the assistance while most likely to succeed in raising funds. These governments, one source points out, still operate fiscal surpluses, while many of their peers are deeply in the red.
Second, the scale of the programme is tiny: Shanghai and Shenzhen have announced plans to issue Rmb7.1 billion ($1.1 billion) and Rmb2.2 billion, respectively, while Zhejiang and Guangdong were reported by Chinese business magazine Caixin as looking to raise Rmb6.7 billion and Rmb6.9 billion, respectively. That’s a total of Rmb22.9 billion, as against a national audit office estimate of total local government debt in China of Rmb10.7 trillion at the end of 2010. While China has an admirable history of piloting fiscal reforms on a small scale to test implementation before rolling them out nationwide, the slow pace of those reforms means increasing issuance to a greater level might take too long.
The real problem is that China’s local authorities are grossly reliant on the property market for their revenues: as much as 50% of total direct government revenues, according to a China analyst at a US bank, comes from property-related income such as taxes and land sales. Furthermore, the assets underlying further borrowing often turn out to be land or real estate. Allowing local governments to issue bonds directly to the market is a healthy long-term step towards diversifying their funding strategies but it does little to solve the short-term problem. For many of China’s local governments, the books simply do not balance and the problem is not going away soon.