China to Impose Quota on Local Government Debt Amid Risks

China announced plans to cap the amount of debt local governments can take on and ban them from additional borrowing through financing vehicles as authorities step up efforts to control risks to the financial system.

All borrowing by provinces and cities will need to be within a quota set by the State Council, China’s cabinet, and approved by the National People’s Congress, according to a statement posted to the central government’s website today. No figures were given for the possible amounts of the quotas. The central government won’t bail out local authorities, it said.

China’s borrowing spree since the global financial crisis has prompted economists including those at JPMorgan Chase & Co. to compare it to debt surges that tipped Asian nations into crisis in the late 1990s and preceded Japan’s lost decade. The government is trying to rein in financial risks without worsening an economic slowdown.

The effect on growth may be “short-term negative, long-term positive,” said Tommy Xie, a Singapore-based economist at Oversea-Chinese Banking Corp. “Short term, local governments will be more cautious, which may trigger deleveraging -- long term, the transparency should boost the efficiency of resource allocation.”

China’s stock market is closed through Oct. 7 for a weeklong holiday after the Shanghai Composite Index gained 12 percent this year. The offshore yuan strengthened 0.2 percent, the most since June, to 6.1658 per dollar as of 2:35 p.m. local time in Hong Kong.

Judging Officials

Debt levels will be included as a “hard criteria” to evaluate officials, the statement said. Local governments will be granted “limited discretion” over borrowing, including issuing bonds for public-service projects. They should ensure financing for existing projects, it said.

Local-government debt swelled 67 percent from the end of 2010 to 17.9 trillion yuan ($2.9 trillion) as of June 30 last year, according to the National Audit Office. Almost 40 percent of local governments’ liabilities came from off-budget funding through their more than 7,000 financing vehicles, the auditor said in December.

Today’s statement comes after China’s legislature passed amendments to the nation’s budget law at the end of August that lay the legal framework for allowing local governments to raise funds by directly selling bonds.

Roads, Bridges

Provinces and cities had previously side stepped rules banning them from directly issuing debt or taking bank loans by setting up thousands of companies to raise money for roads, bridges and sports stadiums.

China will only allow local governments to borrow for capital expenditures on non-profit projects and “moderately” for repaying existing debt, according to today’s statement. They won’t be allowed to raise money for general spending purposes, it said. While local governments can have “limited discretion” on borrowing, their financing vehicles will be banned from adding additional government-related debt, the statement said.

China’s chief auditor said in June that growth in local government debt has already slowed, a sign that tighter scrutiny of borrowing, a crackdown on shadow banking, and economic weakness have curbed credit.

China’s economy will probably expand 7.3 percent this year, according to a Bloomberg survey of economists from Sept. 18 to Sept. 23. That would be the slowest pace since 1990. Authorities have been reluctant to use broader stimulus to prop up growth, instead taking targeted steps such as this week’s easing of mortgage policies to aid the housing market.

When local governments run into trouble repaying debt,they should cut the scale of projects, reduce public spending, and sell assets to raise funds, today’s statement said. They should not interfere with financial institutions’ normal business and force them to offer financing support, it said

— With assistance by Jun Luo

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