China Seeks to Counter Illegal Financing as Infractions Spread

Regional Chinese governments increasingly use “illegal and irregular” methods to fund their work, the Finance Ministry said, drawing attention to the challenges China faces in tackling $1.7 trillion in local debt.

Regional governments have wrongly injected assets into financing vehicles and borrowed illegally from non-bank institutions, the ministry said in a notice posted on its website today. Local leaders must head off “fiscal and financial risks” by correcting that wrongdoing, the ministry said.

The notice reflects concern among China’s new leaders over local government debt, which reached $1.7 trillion by the end of 2010, according to China’s National Audit Office. Finance Minister Xie Xuren has pledged to increase local governments’ tax income as part of fiscal reforms aimed at easing the debt burden.

“A fundamental solution is still absent for the problem,” Sun Mingchun, the head of China research at Daiwa Capital Markets in Hong Kong, said by phone today. “Local governments are undertaking a lot of projects and duties but they are not given financing options -- it’s just unreasonable.”

Sun said governments should be allowed to sell bonds so they don’t have to rely on “back door” ways of raising money.

Local governments must not count on future revenue from land sales to finance debt vehicles, according to the notice. They also shouldn’t raise funds from the public or use schools as loan collateral, it said.

The ministry issued rules earlier this month barring government and Communist Party agencies with administrative powers from selling debt and offering guarantees for others unless they had the legal authority to do so.

Credit Positive

Moody’s Investors Service said Dec. 12 the reforms outlined by Xie, the finance minister, would enhance local governments’ transparency and budget flexibility.

The Chinese government has not updated the local government debt figure ever since it published the $1.7 trillion figure in June 2011. Chinese Premier Wen Jiabao said at a briefing in March that China added only 300 million yuan ($48 million) net local government debt in 2011 and the debt level was within a “controllable and safe” range.

To contact the reporter on this story: Xin Zhou in Beijing at xzhou68@bloomberg.net

To contact the editor responsible for this story: Paul Panckhurst at ppanckhurst@bloomberg.net

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