Municipal debt market takes big step forward

Finance Ministry allows 10 local governments to directly issue bonds to help fund their projects

China will for the first time allow 10 local governments to sell bonds directly to fund development projects, a step that analysts said is a leap forward but still far from a Western-style municipal bond.

The Ministry of Finance on Wednesday posted a statement on its website that identified the 10 governments. They are the cities of Beijing, Shanghai, Shenzhen and Qingdao; the wealthy eastern provinces of Zhejiang, Jiangsu, Guangdong and Shandong; and the inland regions of Jiangxi and Ningxia.

The development confirmed a Tuesday report by China Daily.

Six localities were already covered under an earlier pilot program. Beijing, Qingdao, Ningxia and Jiangxi were newly added.

A major difference between the latest plan and the trial program is that the 10 governments may issue bonds independently. They're also responsible for repaying the principal and interest on their debt.

Under the previous program, the Finance Ministry would repay the principal and interest on local governments' behalf, constituting de facto backing for the bond.

"The new plan means local governments will repay the debt from their own budgets. They can decide how the money raised is spent, which is a step forward," said Li Yan, an analyst with China Chengxin International Credit Rating Co Ltd.

Ivan Chung, senior vice-president of Moody's Investors Service, said the move will undoubtedly boost fiscal accountability and prudence of local governments.

"Before, their funds were mainly borrowed from financing vehicles, which lacked transparency and made it difficult for the central government to manage the risks. For local governments, selling bonds means they will face the market directly and they have to behave responsiblely. Financing costs could be lowered compared with former ones. For investors, this means more investment options," Chung said.

The Finance Ministry will set annual quotas for each government that can't be rolled over to subsequent years. The municipal bonds will be rated, with the 10 local governments to disclose basic information on the bonds, including their fiscal and economic conditions and indebtedness.

"This is still far from a genuine municipal bond market, because the quota, maturity and structure are still dictated by the central government," said Li.

According to the Finance Ministry, 40 percent of the bonds will have a term of five years, 30 percent of seven years and the remaining 30 percent of 10 years.

Investors will probably demand higher yields because the local authorities will repay the debt themselves. But Li said it is still too early to make any further assumptions about pricing until the local governments hire underwriters to start selling the debt.

Separately, the nation's top economic planner, the National Development and Reform Commission, said in a statement on Tuesday that China will create a financing system for local governments under which municipal bond sales will be a "major" funding source.

Financing vehicles, which are set up to borrow on local governments' behalf to skirt laws that ban direct borrowing, will be phased out.

These changes in the bond market will provide new opportunities for credit rating agencies such as China Chengxin and Dagong Global Credit Rating Co Ltd.

Dagong Chairman Guan Jianzhong said that the government should limit competition in the ratings sector to avoid the "mistakes" Western ratings agencies made that contributed to the 2008 financial meltdown.

Those agencies have been criticized for underestimating the risks of many structured finance products such as mortgage-backed securities, in part because they were competing for business from issuers, which typically pay for the ratings.