Shanghai is set to become the first Chinese local government to directly sell bonds in 2012 having made plans issue Rmb8.9 billion (US$1.4 billion) in the next few weeks, according to reports.
Other municipalities will follow suit as declining revenues, combined with increased spending on infrastructure, drive them to the bond market, say analysts.
Revenues of local governments grew by 14.4% year-on-year to Rmb3.2 trillion (US$500 billion) in the first six months, according to the Ministry of Finance. However, this was much lower than the 36% growth rate reported during the same period last year.
The rate was nearly twice as much as the growth of the world’s second-largest economy, which expanded 7.8% in the first half of the year, but it may not be fast enough to meet the demand from the growing investment fever emerging among local authorities.
As a result, China economists believe that the domestic bond market will see a flurry of activity in the second half as local authorities look for alternative sources of funding to boost their investment expenditures.
“I’m not surprised that there is a need to boost the inflow of funds, which were not meeting the revenue targets,” said Dariusz Kowalczyk, senior economist and strategist for Asia ex-Japan at Crédit Agricole to Asiamoney PLUS on August 20. “At the same time local governments need to raise funds to stimulate the economy because the Chinese stimulus is going to local and regional governments to a larger degree.”
For example, China has increased its budget for railway investment by 16% to Rmb470 billion this year, data from the Ministry of Railways showed, a fresh sign that Beijing is seeking to boost the economy through infrastructure spending.
Additionally, Changsha, the capital of central China’s Hunan province, has unveiled an ambitious infrastructure-development package that would require investments of Rmb829.2 billion.
But in order to see increasing activity in China’s domestic bond market, Beijing needs to further relax the direct participation of local municipalities’ in the nation’s domestic bond market, notes economists. This will eventually reduce the dependency on local government funding vehicles (LGFVs).
“We need to allow more local governments to tap the bond market directly. The reason for that is mainly because we need the market to impose some discipline on local government financing practices,” said Mingchun Sun, head of China research at Daiwa to Asiamoney PLUS. “Because banks are not allowing local governments to borrow directly in the local market, it forces them to do financing in a hidden way through LGFVs, which is even worse.”
Shanghai’s upcoming municipal bond issuance is a sign that local governments are looking for alternative sources of funding. Shanghai will sell the bonds in two tranches: Rmb4.45 billion of five-year paper and Rmb4.45 billion of seven-year paper.
Experts believe that this could bolster the city’s declining fiscal revenues – which saw a 13% decline in business-tax revenue in the first half to Rmb50 billion – and spur its infrastructure investments.
“It’s an important development that they’re coming to the market. As China’s bond market develops and provides a better avenue for funding for the entire economy, there will be more issuers that will tap funds this way. I’m sure others will follow suit after Shanghai,” said Kowalczyk. “The proceeds could go to various infrastructure developments that are actively being rolled out across China in order to fund the stimulus of the entire economy.”
China began issuing local government bonds in 2009 to broaden local authorities' financing channels.
The Ministry of Finance sold all such bonds on behalf of the local authorities in 2009 and 2010, before Beijing launched a trial programme in late 2011 to allow Guangdong, Shanghai, Shenzhen and Zhejiang to sell bonds directly, a potential first step toward bringing China's local-government finances in order.
Daiwa highlights that Beijing, and Jiangsu and Shandong provinces have the potential to be the next ones on the list of approved locations to directly tap the bond market.
“The financial strength of these municipals is what gives them the potential. Financial strength is the capability of being able to repay the bonds in the future,” said Sun. “It’s more about the fiscal revenue growth potential of these local governments.”
China is allowing local governments to sell a combined Rmb250 billion of bonds this year, more than the Rmb200 billion of such bonds offered in each of the past three years.