June 26 (Bloomberg) -- China has shelved plans to allow local governments to sell bonds directly following a trial program last November, a week after increasing scrutiny of default risks at regional investment companies.
A draft revision to the budget law that would have allowed the authorities to sell bonds within an approved quota was removed in the second reading of the bill by the legislature, the official Xinhua News Agency reported. The central government will continue to sell bonds on their behalf, it said.
“The central government now is quite concerned about the debt at the local-government level,” said Ivan Chung, an analyst at Moody’s Investors Service in Hong Kong. “They worry that if they give the green light now, probably the local governments have less incentive to deal with their debt problems, because they understand they are allowed to refinance.”
A 1994 ban on regions issuing notes directly led to the creation of more than 10,000 local-government financing vehicles, which increased borrowing as part of stimulus spending designed to cushion the economy during the global financial crisis. As of the end of 2010 they had debts of 10.7 trillion yuan ($1.7 trillion), 27 percent of China’s gross domestic product, according to a June 2011 official audit.
This year, the vehicles have sold 330 billion yuan of corporate bonds, according to data from Beijing-based China International Capital Corp., compared to 350 billion yuan for the whole of last year. In 2009, they sold 425 billion yuan, the data show.
China’s National Development and Reform Commission, the nation’s economic planning agency, told regional authorities to set up risk monitoring and forecasting mechanisms for debt maturing in 2012 and 2013, two people with direct knowledge of the matter said last week, who asked not to be identified because they weren’t authorized to speak to media. The orders were issued because the risk of defaults is increasing as the bond market expands, they said.
Local governments can still issue bonds under the new budget law if the central government gives them approval, Moody’s Chung said, which keeps to door open for a revival of future issuance. The finance ministry will sell 21 billion yuan of five-year bonds on behalf of local governments on June 29, according to a statement on the Chinese bond clearing website. The bonds will be sold on behalf of Qingdao, Guangxi, Hainan, Chongqing, Shaanxi, Xinjiang and Gansu.
“The central government is backtracking as it is worried that it will aggravate the debt problem,” said Rees Kam, a strategist at SJS Markets Ltd. in Hong Kong. “The banking system already has a potential problem of local-government debt turning sour. They don’t want to worsen the situation because, at the end of the day, the central government needs to pay the bill.”
China’s local governments have often used land for collateral for loans and bond sales by their financing vehicles that in some cases have received top AAA credit ratings. China’s home values fell in a record 54 of 70 cities tracked by the government in May, according to data released on June 18 by the statistics bureau.
“Local-government issuance is not the solution to the broader problem,” said Stephen Green, head of Greater China research at Standard Chartered Plc in Hong Kong. “We need transparent government budgets and proper supervision of local-government spending.”
China started a trial program last November to allow local governments to sell bonds directly for the first time in an attempt to start a municipal bond market and increase transparency. The cities of Shanghai and Shenzhen, as well as the provinces of Zhejiang and Guangdong, were the first to sell debt.
The trial bond program enabled cities to cut borrowing costs. The southern city of Shenzhen sold three-year bonds priced to yield 3.03 percent in November, compared to the yield of 3.11 percent on three-year Treasuries on the same date, according to data compiled by Bloomberg. This year, no further cities or provinces have sold bonds directly.
Legislators were worried about the spreading of European deficit woes during the first reading of the bill in December, the financial magazine Caixin reported on its website today, without saying where it got the information.
“The recent European debt crisis has had a deep impression,” Moody’s Chung said. “The central government is concerned that the local governments will continue to increase their debt and it could become a problem.”
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