China to be top issuer of local government bonds

China is likely to become the world's largest local government bond issuer within five years — given the fast growth of the Chinese version of municipal bonds — as a way to facilitate debt restructuring reforms and further strengthen fiscal consolidation, an expert said.

The move would mean outstanding local government bonds, 14.74 trillion yuan ($2.3 trillion) by last week, may increase by over 50 percent to surpass the United States, currently the largest issuer, the expert said.

"In 2018, local governments are predicted to issue more new bonds than last year, with a larger proportion, or up to 50 percent, being the special bond, which may lead to a rise of the debt ceiling to more than 20 trillion yuan," said Qiao Baoyun, head of the Academy of Public Finance and Public Policy at the Central University of Finance and Economics.

This year, the Ministry of Finance is planning to promote the issuance of the special local government bond as part of a proactive fiscal policy to stabilize economic growth, according to a senior official with the ministry.

The special bond, one of the two types of Chinese local government bonds, is repaid by financial returns earned by investment projects instead of the government's general revenue. It usually has higher coupon rates and risks and comes without government guarantees to be paid back. Investment projects include toll roads and subways.

The possible issuance amount has been discussed at the ministry and it will be reported to the National People's Congress before the launch of the annual fiscal budget in March, the senior ministry official, who declined to be identified, said.

The first local government special bond was issued in July 2017 in Beijing to buy land. Its total value had increased to 158.95 billion yuan by the end of September, the Finance Ministry said.

Issuing this new type of bond is seen as a measure to curb the country's "invisible" local debt growth stimulated by local government financing vehicles, while supporting key investment projects to stabilize economic growth.

"Once the back door (fundraising through illegal activities) is closed, the front door (bond issuance) should be opened wider to ensure capital that is needed by the local governments," Qiao said.

Finance Minister Xiao Jie said recently that curbing local governments' debt risks and cracking down on illegal fundraising activities is one of the priority tasks this year.

By the end of 2017, the total local government debt balance stood at 16.47 trillion yuan, below the government-targeted ceiling of 18.82 trillion yuan, the ministry said.

The incremental part of local government debt last year was 4.36 trillion yuan, composed of 2.36 trillion yuan or 54 percent by general bonds and 2 trillion yuan or 46 percent by special bond.

Given a possible rising fiscal deficit and strengthened fiscal discipline applied locally, economists predicted modest fiscal consolidation in 2018.

Because the special local bond issuance approved by the National People's Congress is excluded from budgetary deficit calculations, it can, to some extent, increase the tolerance for a larger deficit within the fiscal budget than the budgetary target, said Zhu Haibin, chief China economist at JPMorgan Chase & Co.