beyondbrics

Much has been made about the huge debt-pile that China’s local governments have taken on to fund infrastructure projects over the past three years. But just how big of a headache has China’s municipal debt problem become?

Big enough it seems for Beijing to finally act.

In a move aimed at giving its cash-strapped local governments a much needed funding boost (and reduce the possibility of defaults), China’s finance ministry on Thursday approved a trial programme that will allow the cities of Shanghai and Shenzhen, as well as the provinces of Zhejiang and Guangdong to issue short-term bonds.

According to official figures from June, local government debts stood at Rmb 10,700bn ($1,700bn) at the end of 2010 – or about 27 per cent of China’s gross domestic product. However, Victor Shih of Northwestern University argued on beyondbrics that this figure could be much higher at between Rmb15,400bn and Rmb20,100bn while Moody’s said China’s National Audit Office has underestimated the local government debt load by some Rmb3,500bn.

Regardless of the precise figure, the ability to issue bonds will certainly go some way to help the municipalities, which have been feeling the sting of Beijing’s efforts to rein in inflation and property prices, to repay their debt.

But the big question though is: who will buy these bonds and at what rates?

As colleagues on Alphaville and Tilt have noted, appetite for debt issued by the central government has been on the wane amid concerns about the creditworthiness of local governments and a slowing debt market. The Ministry of Finance, which has been selling local bonds on behalf of local governments, failed to attract enough investors for its three-year local government bonds in July – the first time since it began such sales in 2009. It sold Rmb23.9bn worth of three-year municipal bonds at a 3.94 per cent yield, less than the Rmb25bn it had planned to raise.

Likewise, the Ministry of Railways also failed to attract enough bids for its Rmb20bn issue in July, while China Development Bank had to cancel a bond sale in June because of “market conditions”.

Meanwhile, yields on China municipal bonds have been ticking up slowly. From 2.8 per cent last June, short term municipal bonds issued in August carried a coupon price of 4.3 per cent.

Nonetheless, analysts reacted positively to the news.

“I think this is certainly a step in the right direction,” Donna Kwok, Greater China economist at HSBC told beyondbrics. “Allowing local governments to issue debt under their own name should enable the debt to be priced at a level more reflective of the local government’s own credit quality – as opposed to the ministry of finance who until now has issued all local government debt on their behalf.”

“In the longer run, it should also sow the seeds of incentive for local governments to get their books and creditworthiness in order,” she added.

The view was echoed by Li Cui, chief China economist at RBS.

“Overall it should be positive as it prepares the institutional framework to deal with the debt issues,” she told beyondbrics.

Beijing’s move to let the cities off the leash and issue their own debt is one thing – whether the government will step in if any of the new city issuers need bailing out is another.

Related reading:
China: a debt baby’s photo album, beyondbrics
Guest post: China’s local debt problems – the next Europe?, beyondbrics
Guest post: China’s non-bank credit bubble, beyondbrics
Waiting for a Chinese local debt disaster, Alphaville
Chinese local govts to sell bonds, but will investors buy? – FT Tilt