Editorial, page 1

Issue No. 541, Oct 24, 2011

Translated by Song Chunling

Original article: [Chinese]

News of the pilot project for four local governments to issue their own bonds is both welcome and worrying.

Although the pilot project is another step towards allowing local governments to issue bonds independently, building on the central government’s decision to do so on their behalf from 2009, we think project has been severely weakened by concerns about its risks.

It’s great that local governments have more autonomy over issuing bonds. As we know, they’re already heavily indebted. The National Audit Office's survey of local government debt showed a total of 10.7 trillion yuan, while some experts think the number might be bigger still. Under these circumstances, it’s no use to try and cover local debts through the budget and，sooner or later， local governments are bound to get full permission to issue bonds.

The pilot project is intended to allow local governments some time to adapt, however the Ministry of Finance documents lay bare its concerns about the project and its risks. The pilot doesn’t just limit the size of the local government’s bond issuance, it also sets the years of issue. It also adds that, if necessary, the Ministry of Finance will meet the local governments’ obligations, and that the interest rates will be determined by auction.

The ministry’s concern is understandable given the 10.7 trillion yuan of the local government debt accumulated in the two years after the financial crisis. Local governments promoted various investment schemes and exceed the four trillion yuan allocated by the central government. Financing platforms were set up that constrained banks and impeded the general development of the economy. What will local governments do if they’re now given the green light to issue their own bonds? What will the effect be on debt levels and the wider economy? These questions are hard to answer and the ministry’s caution is apparent in its decision to limit the pilot to only a few regions, where governmental finances are sound.

However, this decision has also diminished the effects of the pilot project. It’s as though the ministry wants to school local governments in how to issue bonds, instead of actually letting them do so. Although it makes sense to get them following the right procedures, if our real intention is to allow local government to issue bonds independently then our pilot project ought to be more focused on the risks.

The key to these bonds ought to be the price. The market should be the criteria to assess local governments’ ability to repay their debts, and if so the appropriate rates on those loans. However the precondition of that assessment is the transparency of local government accounts. Nobody can get the reliable data about their income, expenditure or liabilities when most of them don’t publish their budgets. The publication of accounts and their reception by the market is an efficient way to restrain the local governments’ growing debt crisis.

However, even if the local governments learn from their schooling, the issue needs to be thought through more carefully. If local governments are really able to issue their own bonds one day, how can we enforce a system of restraint and discipline? Unless we work on a disciplinary system, local governments might never really be able to issue bonds independently.

According to the Ministry of Finance’s orders, the bonds issued by the pilot zones will still be backed by the nation’s guarantee. This hardly gives investors the impetus to assess the financial health of the pilot zones themselves, and is unlikely to have any effect reining in local governments. Regardless of whether the central government issue bonds on behalf of local governments or those governments issues them “on their own”, the central government remains “the ultimate debtor”. Shouldn’t the pilot project try to reconcile greater independence for local governments with Beijing’s understandable concerns about their debts?