What does RMB16 trln quota of local government debt mean

The 16th meeting of the 12th secession of the Standing Committee of the National People’s Congress held on Aug. 29 passed the resolution on the Proposal on Quota of Local Government Debt in 2015 for Deliberation and Approval of the State Council.

Analysts believe that despite the great growth in debt size compared with 2013, the debt risks are still under control. After setting the size of the local government debt, the swap of local government debt in the future will be clear and the pricing of local government bonds will be more market-based.

Risks of local government debt under control

The 16 trillion yuan of local government debt quota in 2015 approved this time are actually the debts which local governments have obligations for their repayment. The quota composes of the local government debt balance of 15.4 trillion yuan across the country by end-2014 and the new quota of 0.6 trillion yuan of local government debt in 2015 approved by the National People’s Congress in March.

Based on the statistics released, the debt size assumed by the government reaches 15.4 trillion yuan from 10.89 trillion yuan in the end of the first half of 2013, increasing 41.4 percent. While the debts for which the government has no guarantee responsibilities but may have certain subsidizing obligations increase to 8.6 trillion yuan from 7.01 trillion yuan in the end of the first half of 2013, increasing 22.7 percent.

Despite the great growth in debt size from 2013, Zheng Chunrong, a professor at Shanghai University of Finance and Economics, believes that the debt risks are under control. Zheng believes that most of the local government debt capitals flow to public infrastructure in the urbanization. These fixed assets investment will greatly reduce the traffic and labor costs in the future, improve the national output and increase fiscal revenue to successfully return the principal and interest of the debts. Considering the small size of central government debts, the total size of Chinese government (including the central government and local governments) debts is not big and the debt risks are controllable and preventable.

The proposal approved this time clearly sets not exceeding 100 percent debt rate as the overall risk warning line of China’s local government debt. Lou Jiwei, Minister of Finance, indicated during his explanation to the Standing Committee of the National People’s Congress that the debt rate of national local government debts is expected to reach 86 percent by end-2015. The risks are controllable in general, but the debt risk is high is some regions.

Market determines pricing of local government bonds

According to the Budget Law which took effect this year, the only legal form of loan assumed by local governments is local government bond. For the existing 15.4 trillion yuan local government debt, they will be swapped gradually by issuing local government bonds. The 3.2 trillion yuan local government bonds issued this year is mainly used to replace the local government debt due this year.

The research report on constant return released by China International Capital Corporation Limited points out that the interest rate of local government bonds publicly issued recently is 10-15bp higher than that of treasury bonds in general. Though there is till gap with the reasonable premium of 20-40bp, it is improving.

Yang Zhiyong, researcher of the National Academy of Economic Strategy, CASS, indicated during the interview by Shanghai Securities News (SSN) journalist that it’s challenging to issue local government bonds in large scales and the pricing should be adjusted according to market changes. To let market power to determine reasonable level of local government debt so as to further improve the usage efficiency of local government debt and the development efficiency of local economy. Li Qilin, constant return analyst of China Minsheng Banking Corp., Ltd. (600016.SH; 01988.HK), believes that the adjustment of debt structures suggests that there might be more moves in the debt swap program for local governments. During the process of depriving local governments’ financing functions, the financing demand of some under-construction projects will be met by bank loans. In the mid-term, the standardized management of local government debts helps to constrain local demand on financing and contributes to the decrease of risk-free interest rate.