Moody's Investors Service notes that the Chinese government has selected 10 provinces and cities to issue for the first time bonds in their own names and to assume responsibility for the repayment of the associated interest and principal.
Moody's considers that this announcement-posted on the ministry of finance website on May 21, 2014-represents a critical step towards the development of a fully functioning local government bond market in China.
Moreover, its implications are credit positive because it will increase the transparency of the fiscal and debt activities of the country's local governments and would lead to greater accountability on the part of local governments with respect to their investing and borrowing practices. Up until now, aside from a small pilot project, most local governments have issued debt indirectly through local government financing vehicles and other government related entities which has clouded the issue of who is responsible for the debt and led to riskier forms of borrowing.
To the extent that this model is replaced over time by a direct borrowing approach, it will make borrowing activities clearer and enable the central government to better supervise and monitor local government debt activities.
Moody's further believes that the selection of a geographically and economically diverse group of provinces and cities provides a strong indication that the government intends eventually to roll the program out nationwide.
The selected locations include wealthy eastern cities and provinces such as Shanghai, Zhejiang, Guangdong, Shenzhen, Jiangsu, Shandong and Qingdao, as well as less developed hinterland locations, including Ningxia and Jiangxi.
While the new announcement does not provide details on the disclosure required for local government bond issuances, we think that the budget execution report delivered in March this year during the Chinese parliamentary sessions or ''two sessions'' indicate what kind of reporting will be required.
This report specified that local governments will need to implement comprehensive reporting and disclosure of all their revenue and expenditures; multi-year fiscal planning including three-year projections; and accrual accounting and reporting of debt in their budgets.
All of this information, if provided, would lead to greater transparency and therefore we believe a sector that would be much more accountable for its fiscal and debt activities.
Our understanding is that the amounts to be issued under the new program will be small and within the levels of the current RMB400 million pilot program. Moreover, the Ministry of Finance will remain involved in the process, for example, setting annual quotas for each local government.
However, as indicated, this latest announcement is still an important step in a gradual, but steady process towards the establishment of a local government bond market.
In addition, over the coming months, it has been reported that the budget law which currently restricts the borrowings of local governments will be revised to allow them to issue bonds.
The latest announcement follows a pilot program established in 2009-which included 31 provinces and 5 centrally planned cities- and extended in 2011 and 2013 to allow six entities to market their bonds. But these programs were fully under the aegis of the ministry of finance.
