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RPT-Fitch: China's Local Gov't Bond Decision is Credit Positive
May 22, 2014 / 10:43 AM / 3 years ago

RPT-Fitch: China's Local Gov't Bond Decision is Credit Positive

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May 22 (Reuters) - (The following statement was released by the rating agency)

The Chinese Ministry of Finance’s (MOF) decision to allow local and regional governments (LRGs) to issue bonds directly on their own credit profile is a significant step forward in reforming LRG budget management and ensuring greater fiscal transparency, Fitch Ratings says.

The decision enables 10 designated LRGs to issue bonds independently in the domestic market up to an annual limit set by the MOF. Unlike a separate pilot scheme, launched in 2009, under which LRGs issued bonds under the aegis of the MOF, debt-servicing responsibilities under this mandate is to be assumed by the local governments themselves.

The designated local authorities are primarily from the wealthier eastern and southern coastal regions including Beijing, Shanghai and Guangdong, but the less-developed provinces of Jiangxi and Ningxia in the central/western region have also been included.

The issuance of LRG bonds is being allowed within a clearly established regulatory framework. The bonds will have to be rated by ratings agencies, and LRGs will be required to regularly disclose fiscal revenues and expenditures and the size of their debt. Furthermore, the amount of local bond issuance is to be approved by the State Council on an annual basis, and LRGs will be required to report all credit-significant events to the Ministry of Finance.

Enabling LRGs to issue debt has several key implications which are positive for credit. First, it will encourage local governments to transfer some of their sources of financing away from local government financing vehicles (LGFV) and off-budget financing. The rapid growth of such funding (Chinese local government debt reached around USD2.9trn as of latest national audit data, most of which has been issued by LGFVs) is a potential risk for Chinese LRGs and a sensitivitity factor for China’s sovereign Local-Currency IDR (‘A+').

Taking financing away from LGFVs and shadow banking, and placing debt issuance under a clearly established central government oversight framework, will bring much greater transparency to LRG fiscal accounts and debt. Notably, it will provide a mechanism for the regular provision of data on aggregate LRG debt and other key fiscal metrics. This in turn will enable the authorities to monitor leverage and their debt-servicing abilities more efficiently - significant steps towards addressing existing weaknesses in the LRG sector.

It also offers the potential for better management of the LRGs’ asset/liability maturities while bringing down borrowing costs. LGFV bonds are often short-dated relative to the expected returns from the investments they are financing. As a result, the new financing options should enable local authorities to more effectively balance the needs of local economic development directly with the LRG’s leverage and debt-servicing capabilities. Off-budget financing through the shadow banking sector also tends to be short term and with high interest.

In addition, we expect this pilot scheme to allow for more accurate pricing of risk, in light of the differing credit profile of LRGs. Local bonds will more accurately reflect the individual inherent creditworthiness of the authority rather than the sovereign’s potential support, as was the case with the other issuance programme. If this pilot scheme is expanded, it will also allow for a more transparent assessment of the Chinese LRG sector, and result in a more sophisticated and responsible debt management policy.

The decision is a positive step forward to improve transparency and create more sustainable financing options for LRGs. However, it does not stop local governments from continuing to source funding through LGFVs and off-budget financing. In addition, it does not reduce LRGs’ legal responsibilities to support existing LGFVs. As such, we view this development as an improvement and an indicator of potential nationwide reforms to LRG financing, but not a comprehensive solution.

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