SHANGHAI (Reuters) - China's parliament has formally approved changes to the budget law allowing local governments to issue bonds directly, a reform that could help stabilise government financing by creating the country's first municipal bond market.
Regulators have already experimented with allowing local governments to issue debt directly through a pilot programme under way. The amendment to the budget law that the National People's Congress passed on Sunday would certify the pilot and provide a legal basis for later expansion.
The National Audit Office estimates local governments owed 17.89 trillion yuan (1.75 trillion pounds) as of the end of June and says nine Chinese provinces failed to pay back some 800 million yuan of debt due in March.
As economic growth slowed, that situation apparently caused regulators to move faster on developing alternative funding channels for local governments, given estimates that a fifth of local government debt is set to come due in 2014.
Beijing is worried that funding pressures on local governments would exacerbate their reliance on land sales for revenue, something that has caused social disruption as governments evict residents to sell land to developers.
Minister of Finance Lou Jiwei said in an interview published on official websites on Sunday that he believed the local government debt situation had stabilised this year.
"Of course we can issue some new bonds, and we can pay off some old bonds, but the total amount (of outstanding debt) hasn't clearly expanded, the total risk is controllable," he said.
Beijing has been struggling to find a way to make local governments more fiscally responsible after they ran up massive debt in the years following the global financial crisis, in many cases using opaque local government financial vehicles (LGFVs), which are now at risk of collapse, to get access to bank credit.
Economists are worried that systems currently in place encourage local officials to over-invest without regard for returns, in the name of supporting economic growth at all costs.
The new law allows governments to issue bonds to fund projects for the public good but not to fund day-to-day operations. It also requires them to publish prospectuses to explain their debt condition and how they will use the funds.
The Ministry of Finance has granted 10 local governments quotas to issue a combined 109.2 billion yuan of municipal bonds this year.
Governments in Shanghai, Zhejiang, Guangdong, Shenzhen, Jiangsu, Shandong, Beijing, Qingdao, Ningxia and Jiangxi are included in the pilot scheme. Most have already conducted their first issuance, starting with Guangdong province, which sold a 14.8 billion yuan issue in June.
Questions remain about how transparent the process will be.
Analysts have lauded the detail contained in some prospectuses but there are concerns about the ability of domestic rating agencies to accurately assess risk and report it to investors, given the pressure to compete for business and political pressure to give local government issuers positive assessments.
However, while municipal governments are responsible for paying off bond investors out of their own budgets, their bonds are considered semi-sovereign debt in China and thus ultimately guaranteed against default by the central government.
"We see some improving trends. Having said that, there's still some room for improvement," said Ivan Chung, a senior vice-president for China credit research at Moody's in Hong Kong.
While the National Audit Office has published information about local government debt, the local governments themselves have yet to publish balance sheets.
"We have more information on the debt side, but we want more details: how much debt is from LGFVs, how much is from local SOEs (state-owned enterprises)," Chung said.
"From the asset side, we have limited information. We know they own some SOEs but they also own other assets -- government buildings and so on -- and we don't have so much information on that."
Editing by Larry King and Alan Raybould