Key Points:

  • Local governments to be authorized to issue bonds primarily for infrastructure projects
  • State Council approval required

Newspapers report that the PRC government is contemplating permitting local governments to issue bonds. A proposal relating to issuance of bonds by local governments has already been drafted by the Ministry of Finance and submitted to the State Council for approval. Meanwhile, the Ministry of Finance has set up a division responsible for the administration of local government debts.  

Under the Budget Law of China, no local government may issue bonds except as permitted by law or the State Council. In recent years, local governments have attempted to avoid these restrictions by borrowing money in other ways. For example, for city infrastructure construction, some local governments have first established a legal entity, using that entity to issue enterprise bonds. For example, in 1999, the Shanghai government used a local company to issue enterprise bonds from which funds were raised and then used for the construction of Shanghai’s metro system. Similarly, for the construction of a water supply system, the Jinan government of Shandong Province arranged for bonds to be issued by the Jinan Water Supply Company. Further, the debts of many local governments are “implicit debts,” for which there seem to be no reliable statistics, though the amount is estimated to be more than RMB1,000 billion.  

In China, taxes and land grant fees are the main sources of income for a local government. The state’s macroeconomic control of the real estate market, complicated recently by the global economic crisis, has resulted in a decline in revenues from taxes and land grant fees, with consequent financing difficulties for local governments. The local government bond proposal will permit local governments to issue bonds to cope with these financial difficulties.  

The key challenge of the proposal is how to control risk if the state allows local governments to issue bonds. At the trial stage, only provincial governments may be authorized to issue bonds. Also, the purpose for the funds raised by the bonds may be strictly limited to infrastructure investment or investment for public use. The state may also establish strict procedures for the issuance of municipal bonds – for example, by requiring preliminary approval by the local People’s Congress, final approval from the State Council and a credit rating.  

If the proposal is approved, it will mark a significant shift in the financing of local governments, and may make their focus more market-oriented.