BOFIT Weekly Review 2015/23
Banks ordered to continue financing local government construction projects in China
In mid-May, the government announced a rule change, whereby banks are obliged to continue financing construction projects initiated by the local governments if the decision to lend to the project had been made before last September.
In addition, the new rule calls for continued bank funding even if revenues from the construction project are ultimately insufficient to repay the loan or even service interest costs. In such cases, the bank must renegotiate the interest rate of the loan and revise the loan repayment schedule to correspond to project returns. The local government retains ultimate responsibility for repaying the loan. If the revenues of the project are insufficient to cover the loan, the local government must finance repayment of the loan either by finding private investors for the project or including the debt in its budget.
Local governments were earlier subject to a balanced budget rule that prevented them from taking on debt. Many circumvented this rule through the use of local government credit vehicles (LGCVs). LGCVs were outlawed last autumn and in their place local governments were granted the right to issue municipal bonds. By allowing local governments to restructure their debts the central government aims to reduce servicing costs and foster financial transparency. These bond-based debt restructurings have not gone without problems. After the low bond yields failed to generate investor interest, the central government had to order banks to purchase the bonds. Jiangsu province was the first local government to sell its bonds in May after a failed bond sale in April.