China has released a long list of amendments to its budget law, ending a 20-year ban on regional governments issuing bonds.
Citywire Asia asked leading investors what impact this will have on regional debt issuance and how the move will help the country’s ongoing financial reform.
Head of Asian fixed income, JP Morgan AM
The new policy has not yet fully lifted the restrictions on local government debt issuance.
Hence the initial uptake will not be that substantial as it currently only covers the province-level administrative divisions and other specifically listed entities.
However, we are positive that this policy will help materially reduce the cost of funding for the entities involved. It doesn’t appear that clear guidance has been provided on whether local governments can issue bonds offshore. Our assumption is that this will not be implemented at this initial stage.
We believe this is a logical step to help resolve the current debt situation. First, transparency is much increased as provinces need to prepare and publicise their full balance sheets. This should increase awareness and restrain the level of debt growth from the provinces.
Second, allowing local governments to issue in their own names will make local government financing vehicles (LGFVs) less opaque. Previously, their higher borrowing costs compounded the credit situation.
Apart from further developing the domestic bond market and expanding the universe of the issuer set, the policy will allow better supervision and regulation of the local government’s balance sheet situation and the appropriate use of funds.
The growth of LGFVs and the existing stock of local government debt also necessitates a more structured bond market for both refinancing this debt and achieving a transparent system for longer-term stability.
Partner and portfolio manager, Stratton Street Capital
The main change here is not that suddenly local governments will be able to issue debt, as they have been doing this for a long time, but rather that it will put this debt on a strong legal footing.
Previously, debt was issued off the balance sheet via LGFVs. These left investors with little information about total debt levels, as well as whether the government would stand by these vehicles if there were problems.
The new rules are in line with pilot projects that already let certain local governments, including Shanghai, Guangdong and Shenzen, issue bonds. This will allow LGFVs to be refinanced when their debt matures, and new debt will be issued.
It is not clear if local authorities will be able to issue offshore directly, although we have already seen the first LGFV offshore issue, from Beijing Infrastructure Investment Co back in June. However, only financially strong LGFVs with strong revenues are likely to be able to issue offshore.
We expect local authorities to be allowed to issue offshore directly at some point, but there is plenty of domestic capital looking for a secure home, so the domestic market will be the most important.
This policy is all part of the same financial liberalisation that includes gradually opening up the capital account, but we do not expect it to directly affect the pace of liberalisation here. Most of the local authority bonds will be replacing existing debt, rather than being a sign of increasing leverage, but with a more stable and secure legal framework.
We think that the main benefit will be refinancing existing LGFV debt, rather than adding to debt. There are around RMB214 billion of LGFV bonds maturing this year, and more next year.
Direct local government bonds should have significantly lower yields, due to their formal guarantee, and the local AAA ratings of many local authorities are higher than even the best of the LGFVs, which are less diversified.
The government has made it clear that it does not want overall debt levels to spiral out of control, and with the new issues being very transparent, unlike LGFV debt, you can be sure that there will be central control of overall indebtedness.
We have been expecting this policy change for some time now. Local authority bonds were originally banned back in 1994, and the policy has become a real problem as off balance sheet debts have grown. The capital markets in China are developing rapidly, and a high-grade municipal market is a logical step.
Senior portfolio manager, Lombard Odier
The new budget law formally legalises local government bond issuance and is an explicit acknowledgment by the central government about the legal standing of local government bonds going forward.
We will see fiscally stronger local governments issue such bonds first and this will lead to the development of a more transparent local government bond market. This is another way for local governments to address the fiscal mismatches they face.
It is not yet clear whether local governments will be able to issue bonds on the offshore market. This is also part of China’s reform measures. Allowing local government bonds will increase the depth and diversity of fixed income investments in China, and this could in turn lead to better RMB investment opportunities in China.
We believe this is part of China’s solution to tackle its regional debt issues. Taken in a global and regional context, the total government indebtedness of China (around 60%) is well within prudent norms.
The new budget law explicitly requires local governments to seek approval from the central government to issue local government bonds, so we believe the total stock of local government bonds will be controlled and most likely allowed for local governments to refinance the debts of their financing vehicles.
The new budget law also mandated a much more comprehensive inclusion of fiscal revenues into the local governments’ budgeting process. For example, land sale revenues, which were previously off budget items, are now formally including in the fiscal budgeting process.
Most interestingly, local governments are now required to publish financial budgeting details after approval. While execution is key, this is a significant and clear improvement in financial disclosures on the local government finances and goes a long way to address the fiscal sustainability of the local governments’ fiscal positions.
This article originally appeared in the October issue of Citywire Asia magazine