China Muni-Bond Stalling Shows Debt Threat as Party Meets
Two years after China started a trial municipal-bond program, plans to take it nationwide have stalled, leaving local authorities reliant on off-budget funding fueled partly by land seizures.
While authorities added two provinces to the trial this year, a draft budget proposal authorizing national sales with approved quotas was dropped in June 2012 and has yet to be revived. This year’s municipal-bond issuance is equivalent to less than 1 percent of local-government borrowing as of 2010, the last official tally.
President Xi Jinping has a fresh opportunity to accelerate efforts to provide more transparent funding for everything from roads to sewers in a conclave of Communist Party leaders that begins tomorrow. While trade data today added to signs of strength in the economy, leaving in place the current model of local borrowing may elevate the risk of a bad-debt crisis.
“The longer they put off solutions, the weaker they could get in terms of their financial position,” said Fraser Howie, Singapore-based co-author of “Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise.” Developing municipal bonds “would be a very clear sign that they were serious about tackling local government finances,” he said.
The four-day gathering will be the third full meeting of the party’s current Central Committee, including General Secretary Xi and Premier Li Keqiang. It was at such a third plenum in 1978 that Deng Xiaoping and his allies inaugurated a series of reforms that began to open up China to foreign investment and loosen state controls over the economy.
This year’s meeting “is expected to be a watershed as drastic economic policies will be unveiled,” according to a Nov. 4 news analysis by the official Xinhua News Agency.
China’s exports rose more than estimated in October from a year earlier after an unexpected decline in the previous month, while import gains accelerated, customs figures showed today. Data tomorrow on inflation, industrial production, investment and retail sales will give more indication of whether last quarter’s recovery is being sustained and how much room leaders have to maneuver.
A building spree has helped maintain China’s economic growth following the global recession. Loans were obtained through more than 10,000 financing vehicles cities created to get around laws prohibiting them from borrowing, according to a central bank count.
Of 186 local authorities that issued bonds or short-term notes through financing vehicles in the first nine months of 2011, more than 100 said they engage in “chaiqian,” a word referring to government demolition of homes. Nationwide, official data show income for local governments from selling land-use rights totaled 7 trillion yuan from 2006 through 2010, according to the book “China’s Superbank” by Bloomberg News journalists Henry Sanderson and Michael Forsythe.
Local governments’ seizures of farmland for property development have been a trigger for protests. China has 30,000 to 50,000 so-called mass incidents a year, with land disputes and environmental issues the main triggers, Chen Jiping, former vice general secretary of the Communist Party’s Committee of Political and Legislative Affairs, said in March.
Expanding the local-bond market is one piece in a jigsaw puzzle of fiscal and financial reforms that also include changes to interest-rate controls and a residence-registration system that limits labor mobility.
Analysts surveyed by Bloomberg News said changes to local-government funding were most urgent, when asked to choose from 11 priorities. The State Council in July ordered the most comprehensive audit of government debt in two years. Standard Chartered Plc estimates regional borrowing has increased since 2010 to as much as 24.4 trillion yuan ($4 trillion).
Expectations for action are high. Twelve of 23 respondents to the survey last month said local-government funding was one of the three most likely areas to see significant reforms in the next 12 months.
The State Council, or cabinet, can expand the local-bond pilot program as desired, and its research arm is calling for permitting more regional-bond sales. Bond sales, under the control of the central government and local legislature, will probably be allowed to replace borrowing by local-government financing vehicles, Credit Suisse Group AG says.
“The direction is very clear: Local governments will have to follow market practices in their financing activities and investment activities,” said An Guojun, a researcher with the government-run Chinese Academy of Social Sciences in Beijing.
“At the same time, the development of a proper municipal-bond market in China depends on many other factors,” from trustworthy credit ratings to governance, said An, who served on a bond-market advisory committee to the National Association of Financial Market Institutional Investors.
Signals are increasing that authorities want to limit debt. The People’s Bank of China said in a report this week that the economy “may see a decline in leverage” over a relatively long period of time, a suggestion that UBS AG said hadn’t been previously mentioned by a government economic agency.
China’s local governments are responsible for 80 percent of spending while getting about 40 percent of tax revenue, the legacy of a 1994 tax-sharing system, according to the World Bank. The local share of spending has surged in recent years, causing regional authorities to rely more on land sales and borrowing via investment vehicles, Credit Suisse says.
“The government is trying to balance setting up a market and also being cautious by not allowing these local governments to start borrowing until there is a framework in place that provides adequate controls,” said Debra Roane, a Sydney-based vice president at Moody’s Investors Service who covers Asian sub-national debt.
While the municipal-bond market will develop in some form, any new borrowing channel will face difficulty because it won’t contain local governments’ power to issue debt or boost spending in “meaningful ways,” Chen Zhiwu, a former adviser to the State Council, said in an e-mailed response to questions.
“The only way out is to increase transparency through a free press and make local governments directly accountable to the local citizens,” said Chen, now a finance professor at Yale University in New Haven, Connecticut. “The problem is not that the financial engineers cannot design the right financial instrument, but a political reforms problem. Without fundamental political reforms, no financial designer has any magic.”
Elsewhere in the world today, France’s credit rating was cut one level to AA by Standard & Poor’s, which said President Francois Hollande’s policies will fail to spur growth and fix public finances. Germany’s September exports rose more than estimated.
Job gains in the U.S. are projected to have slowed in October, and the unemployment rate may have risen to 7.3 percent, according to Bloomberg News surveys of economists ahead of data today. Canada will probably say its jobless rate increased to 7 percent last month, a separate survey showed.
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