BOFIT Weekly Review 2015/11
China’s struggling local governments can now convert more debts into bonds to deal with their debt problems
On Sunday (Mar. 8), the finance ministry announced it would allow local governments to issue municipal bonds this year totalling 1 trillion yuan (€150 billion). The money raised would be used to pay down high-interest loans owed by local government financial vehicles (LGFVs). A new quota adds to an earlier municipal bond quota of 500 billion yuan for this year.
It is not clear how bonds will be issued under the new quota, how old debt obligations will be swapped for new bonds or what protections investors might enjoy. It is also unclear which regions are authorised to issue these bonds. The finance ministry estimates, that the debt-servicing costs of local governments this year will decline by 40–50 billion yuan (€6–7 billion) with the refinancing arrangements.
Earlier, local government budgets were mandated by law to be balanced. This forced local administrators to create off-budget LGFVs to fund their investment projects. This highly opaque approach to financing stood out during the stimulus policies adopted in the wake of the international financial crisis in 2008–2009. At the moment, the indebtedness of local governments is estimated to be around 20–25 trillion yuan (€3.0–3.7 trillion), or around 30–40 % of GDP. Moody’s estimates that about 2.8 trillion yuan (€420 billion) of local government debt comes due this year.
A representative of China’s Banking Regulatory Commission warned this week that the indebtedness of local administrations constitutes the single largest risk to China’s financial markets and fiscal policy. Budget documents, however, provide little indication as to the revenues that projects financed with debt will ultimately generate or how debt-servicing costs of local governments will be financed. This makes any attempt at risk assessment challenging. In any case, debt-swap agreements will only provide temporary respite to the deep debt problems of local governments.