Local Governments Out of Pocket?

By+Wang+Jun

According to a report issued by the National Audit Office， local government debt in China had totaled 17.9 trillion yuan （$2.9 trillion） by the end of June 2013. Of this， local governments are responsible for repaying 10.89 trillion yuan （$1.76 trillion）， which accounts for 61 percent. They also assume the liability of guarantee for 2.67 trillion yuan （$430 billion） and some liability of salvage for 4.34 trillion yuan （$700 billion）， respectively.

Given the poor assessment， local government financing platforms are being squeezed. A financing platform is a venture established by a local government with state-owned assets to build infrastructure and support other projects.

Worse still， officials and economic scholars have warned that local governments will no longer be able to rely on revenues from the transfer of state-owned land use rights， due to dwindling land reserves and the trend of a cooling down property market across the country.

The increasingly real possibility of a huge shortage of funds leaves local governments with the thorny predicament of how they can raise much-needed capital to boost urbanization.

At present， a pilot program for issuing government bonds is underway， and some better-managed bond financing models have emerged to replace traditional local government financing platforms.

Huge gap to fill

In May， the State Council， Chinas cabinet， approved a plan for deepening economic restructuring in 2014， worked out by the National Development and Reform Commission （NDRC）. According to the document， the financing system for local governments will be regulated and local governments will be prohibited from borrowing through their financing platforms.

The aim of the NDRCs document is very clear： Preventing irregular practices of local government financing platforms while giving the green light to municipal bonds.

On May 22， the Ministry of Finance （MOF） announced its move to allow 10 designated local governments to issue and redeem their own bonds within a pilot program. The program involves eight provincial-level governments of Beijing， Shanghai， Zhejiang， Guangdong， Jiangsu， Shandong， Jiangxi and Ningxia. Shenzhen in Guangdong and Qingdao in Shandong are also participating.

“Letting local governments issue and redeem their own bonds will be conducive not only to reducing financing costs for local governments， but also to extending the term of debt and improving the problem of maturity mismatch，”said Huo Zhihui， Vice General Manager of the Rating Department of China Credit Rating Co. Ltd. “Hence it will be a key measure toward regulating the financing system for local governments.”endprint

Huo thinks there will be a growing trend of local governments directly issuing general obligation bonds in the future， but for the short term at least， the size of such bonds will remain small. For the remainder of 2014， the 10 local governments participating in the pilot have been assigned quotas to issue municipal bonds worth 109.2 billion yuan （$17.67 billion）， accounting for 13.18 percent of the combined volume of bonds issued by all local government financing platforms in 2013.

The chasm between the size of local government bonds and the funds needed for urbanization becomes apparent when they are compared. Wang Baoan， Vice Minister of Finance， estimated in March that Chinas urbanization rate will reach 60 percent by 2020， which will prospectively create an investment demand of some 42 trillion yuan （$6.8 trillion）.

When interviewed by Beijing-based Economic Information Daily， Wu Xiaodong， Chairman of Hefei Construction Investment and Holding Co. Ltd. in Anhui Province， calculated that by 2020， 7 trillion yuan （$1.13 trillion） will be needed each year on average. Local governments are currently required to invest at least 30 percent of the funds needed for each urbanization project， and the other 70 percent have to come from private capital. That means each year local governments have to raise 5 trillion yuan （$810 billion） from the market. “It would be unrealistic for local governments to be expected to rely on issuing municipal bonds alone to achieve it，” Wu said.

Wu said that of the 10 local governments taking part in the pilot， none of them can issue municipal bonds worth more than 15 billion yuan （$2.43 billion） this year.

Take Anhui as an example. Even if the province issued 15 billion yuan of municipal bonds， the money raised would have to be shared among its 16 prefecture-level cities. To take that example further， if the provincial capital Hefei were able to get its hands on 4 billion yuan （$650 million）， a lower-level government in the city would still only be entitled to about 400 million yuan （$65 million）. “This would be utterly inadequate for the citys infrastructure construction， representing a drop in the bucket，” Wu said.

In May， the NDRC pioneered an innovation in bond financing for shantytown redevelopment. For the first time， it allowed issuance of project revenue bonds for the rebuilding of dilapidated areas in cities. Project revenue bonds are a financing instrument used by governments to raise the funds necessary to acquire and develop “essential use， public purpose and private activity” projects. The bonds are issued by a government agency and purchased by investors， including but not limited to institutional investors， private investors， or syndicated investor groups.endprint

As opposed to financing measures present in local government financing platforms， project revenue bonds can separate the debts of the issuers from those of local governments， thus effectively preventing the fiscal and financial risks associated with traditional financing platforms.

Ye Feng， an analyst with the Rating Department of China Credit Rating Co. Ltd.， suggests local governments increasingly inject market-oriented business assets and adopt more market-oriented measures to support the transformation of their financing platforms into“real entities” with stable cash flows to issue project revenue bonds.

Ye believes under the guidance of marketand business operation-oriented principles set by the regulatory authority， it will present another option for local governments in regulating direct financing channels by transforming their financing platforms into “special platforms，”such as those that issue project revenue bonds.

The PPP scheme

In order to meet the demand of funds for urbanization， the government may do well to consider the introduction of the public-private partnership （PPP） scheme to complement bond financing， according to Liu Shangxi， Deputy Director of the Research Institute for Fiscal Science under the MOF. He said that this scheme can “unload” the heavy burden on the government budget and stimulate the inflow of more private capital.

A PPP is a government service or private business venture that is funded and operated through a partnership of government and one or more private companies. It involves a contract between a public sector authority and a private party， in which the private party provides a public service or project and assumes substantial financial， technical and operational risks in the venture. In developed countries， this type of scheme is widely used in infrastructure construction projects such as waterworks， power plants， subways and highways， and other nonprofit facilities such as hospitals and schools.

“The MOF is selecting appropriate projects for trial implementation of the PPP scheme among all the existing and newly approved urban infrastructure projects all over the country，”Vice Minister Wang said.

However， the PPP scheme may also bring new risks to local governments if not properly designed and implemented， according to industry insiders.

“Only when the government and private companies both benefit from the projects， will PPP prove itself a good scheme，” said Wu with Hefei Construction Investment and Holding Co. Ltd.

According to Wu， what the government wants are low-cost development funds coupled with efficient management of projects. At the same time， private companies hope to invest in projects that carry low costs and promise stable returns， which are typical to most government projects.

“PPP in and of itself cannot achieve such a ‘win-win situation， and only fair and open tenders made within an equitable competitive environment will make PPP an effective scheme，” Wu said.endprint