November 03,2008

Beijing Considers Municipal Bonds as Economy Booster

By Ma Wenluo

A program on strengthening debt management of local governments drafted by the Ministry of Finance (MoF) has recently been submitted to the central government for approval after consultation. Beijing policy makers seem to agree that allowing local governments to issue bonds is a prudent step to help prevent drastic economic slowing.

China has not before allowed the issuing of municipal bonds over worries that local governments�slack financial management could lead to inflation, not to mention corruption. However, local government voices calling for expanding revenue sources is never-ending. A few years ago, MoF and the State Development and Reform Commission even conducted an in-depth study on the issue.

Against a backdrop of global recession, GDP of China’s export-oriented economy grew by 9.9% in the first three quarters over the same period of last year, down 2.3 percentage points. Premier Wen Jiabao noted on any number of occasions that China's stable and rapid economic development was its greatest contribution to the world economy. The expansion of domestic demand has become an important means to stimulate economic development.

In the face of climbing living costs, particularly in healthcare and education, Chinese people tend to put their cash in banks, the better to cope with unpredictable expenditures, and the contribution of consumption to GDP has been lower than that of investment. Ten years ago, China got through the Asian financial crisis by relying on huge investment in highway construction to stimulate domestic demand. Ten years later, China now hopes to maintain economic growth with high-speed railway construction, and the government has recently announced that the railway investment budget will grow by 60% in 2010.

Local governments must pay not only for the construction of roads, railways, subways, airports, sewage treatment plants, and low rent housing, but must also provide subsidies for residents�heating and urban transport. In recent years, the central government has increased its transfer payments to residents, eliminating tuition for primary and secondary schools, raising the wages of teachers and retired workers, as well as significantly reducing real estate transaction costs announced by local governments. All of these come at the cost of local governments. The division of revenue by central government and local governments is in imbalance. For example, local corporate income taxes go 40% to locals and 60% to Beijng, while value-added taxes go 25% and 75%. In 2007, the take of local governments accounted for only 1/10 of total national tax revenues. Local governments in western regions are on the verge of bankruptcy, unable to pay even the wages of civil service officials. In this case, construction and investment companies established by local governments support expenditures through financing from banks and the stock market, and even get part of transfer payments from Beijing. According to a report from the Development Research Center of the State Council, total invisible debt of governments at all levels in China has reached at least 1 trillion yuan, equivalent to 1/5 of the total tax revenue in 2007.

In recent years, local governments�revenues have become increasingly dependent on leased land and real estate, dubbed "land finance." The revenue from land in Chongqing, China’s fourth municipal city, in 2007 totaled 37 billion yuan of the total revenue of 78.86 billion yuan, 47%. Prior to this, research from the Development Research Center showed the national average revenue from selling the land accounted for about 60% of the total. With the real estate market having gone sluggish, local government revenues have nosedived. Heavily indebted local government-owned construction companies find it difficult to obtain loans from banks. Projects invested in by governments face suspension or termination. Expanding domestic demand through investment by local governments has become well nigh impossible.

Under the pressure of this situation, Beijing’s answer may be the allowing of bond issuing by city and local governments.

However, China's existing administrative system may be a major source of opposition to municipal bonds. At present, more than half of the countries in the world allow local governments to issue bonds, but they must go through strict procedures. For example, the scale of an issue is submitted to the local parliament for discussion and hearing, and any important borrowing needs a referendum. Local councils in China don’t have binding right on government budgets, which consist only of a few pages. Governments are not even clear about their own direct or indirect debt. In fact, only one city in China, Jiaozuo City in Henan Province, produced a budget for its government debt. Reports on misappropriation of special funds by local governments are hardly uncommon. There are even reports of disaster relief funds being diverted to government office construction. After the earthquake in Sichuan, domestic and foreign donors asked that their donations be given to the victims directly, showing how little confidence was placed in local governments.

As far as municipal bonds are concerned, scholars call for the introduction of "sunshine laws" to strengthen legislators�supervision rights over government budgets. Through credit rating and public disclosure, opaque government management and possible misconduct can be checked and the system changed. With proper controls, municipal bonds may become a driving force and means for reform on China's administrative system.



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