Trial program for four borrowers will allow issues of 3-, 5-year bonds

BEIJING - The Ministry of Finance has launched a trial program to allow local governments to issue debt directly, easing concerns of possible default while offering new investment channels for private capital.

The provinces of Zhejiang and Guangdong and two municipalities - Shanghai and Shenzhen - will be allowed to issue three- and five-year bonds, a statement on the ministry's website said on Thursday.

The proceeds of local government bond sales will be kept in a special account at the finance ministry, which will oversee the payment of interest and principal, it said.

Since the central government will oversee the payment of interest and principal, the issued debt will be seen as guaranteed by the State, said Gang Meng, director of the rating committee of Dagong Global Credit Rating Co Ltd. "If a rating is required, it should be triple-A," he told Sina.com.cn.

However, such a guarantee could lead to the "moral hazard" problem, said Xu Xiaonian, an economics and finance professor at China Europe International Business School. "Local governments would tend to borrow more regardless of their repayment abilities," he said at his real-name micro blog.

The move comes amid increasing concerns that the accumulation of local government debt poses the risk of default. Local authorities borrowed heavily to help finance China's 4 trillion yuan ($627 billion) stimulus package after the global economy slumped in 2008.

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Data from the National Audit Office show the debts of local governments stood at 10.7 trillion yuan at the end of last year, equal to 27 percent of the country's 2010 GDP.

China's budget law prohibits local governments from issuing bonds on their own. But many financing vehicles have been set up by local governments to raise funds to circumvent the law and meet demand for financing.

The new rule does not give full "independence" to local governments, as the ministry still controls the scale and use of bond issues, said Liu Shangxi, deputy director of the ministry's Research Institute for Fiscal Science.

Nonetheless, it allows local governments to optimize their debt structure and debt management process, and it will be an effective system since it brings more transparency to the risk control process, Liu said.

A previous report by the 21st Century Business Herald said that Zhejiang, the richest province in China, would issue 8 billion yuan in bonds this year, citing sources from the province's finance department.

The money will be used to fund city- and county-level infrastructure projects that are under construction, and low-cost affordable housing projects, Qian Juyan, head of the Zhejiang Provincial Department of Finance, was quoted as saying.

Zhu Chao, assistant dean of the School of Finance at the Capital University of Economics and Business, said the move signals the start of using more fiscal measures as part of macroeconomic regulation.

"There is very limited scope left for monetary policy when inflation is still high, whereas bond issues could bring many benefits such as absorbing private capital," Zhu said.

"It offsets the decreasing fiscal revenues faced by many local governments as land-sales-supported finance is coming to an end," he said, predicting that the trial program would soon go nationwide.

"The debt scale may also increase as places are set to issue debt, but it will be fine as long as economic growth remains robust," he said.